Is Commercial Real Estate a Sound Investment? Ask Wert-Berater,Inc.

March 30, 2011 - PRLog -- I was in the office of a real estate investor about 3 years ago who owned significant land holdings.  We were discussing their investment strategy.  The client made a comment that astounded me.  It was "Land always goes up in value."

If any of you have researched land prices almost anywhere, I doubt you will find that this conjecture is true given the current economic climate.  In fact, in some areas, land has no value.

Land has costs to hold such as real estate taxes, maintenance, and loss of income known as "opportunity costs" as the money invested does not typically earn a cash flow in most cases unless its rented for a Christmas tree lot or something like that.

Land is worth what rents it can produce.  If a building can be constructed on it, and that building can earn rents the way to calculate land value is value of the rents or cash flow stream after the building is fully operational, less the cost of development and construction, less Entrepreneurial Profit.

What is "Entrepreneurial Profit"?  It is the money that is paid to you for your time invested whereas you could have been earning money doing something else.

Many developers don't consider this as an expense and wonder why in the end of a development, if it is successful why they did not make any money.

Commercial real estate is risky.  There are so many factors that have to be considered.  Many developers present what we call a "Horizontal Pro Forma" statement to their investors.  At the top is the value of the completed building.  In the middle are costs, and at the bottom is the "Bottom Line" or projected profit.

The problem is that development projects take time.  Lots of time.  Pro Forma statements have to be linear meaning that they are projected on a monthly basis over time.  There are many variables to the Pro Forma statement.  There are assumptions that change without the control of the developer.

Some of these changes are internal to the project such as cost overruns for unforeseen reasons, the land entitlement process could be held up, engineering problems, environmental constraints, tenants changing their minds and backing out of contracts walking away saying "Sue me." which is another costs on its own and so on.

Competitors can lower their rents while you are midway in your project and you as the developer forecasted based on market rental levels.  Cost of materials change.  Labour costs can change.  I could go on and on, but by now you probably see my point.

How is this mitigated?  Well, you could purchase an existing building such as an office or retail or even industrial building.  Apartments can be very management intensive and offer lower returns in many cases.  But people need a place to live and apartments if well managed and maintained can provide a stable revenue stream.  But, leases are usually 1 year or less, so it is not easy to predict the future.

Office, retail and industrial buildings often have leases for more than 1 year.  Typically 3 years or more.  Thus, the revenue is easier to understand.

Don't get fooled by brokers who earn commissions to buy something.  Often a good broker will help you to understand the projects you are viewing because that is their job.  But, a third party provider who has no interest in you or your project is best to help you decide.

Appraisals are necessary, but values change.  The values are based on the level of rents in the market and at the project, the market capitalization rates and so on.  The appraisal is only as good as the appraiser and the date of value is it.  It is not good past that date.  Appraisals are a snap shot in time.  Don't spend too much time thinking that an old appraisal has any merit as time goes on.

A feasibility study is the combination of a market study and project financial analysis.  A feasibility study unlike an appraisal is forward looking.  A feasibility study considers all of the risk of real estate ownership from leasing, rental rates, legislative, zoning, competition and all of the "What if?" questions.

Wert-Berater, Inc. provides feasibility studies that consider all risk.  The projections via the Monte Carlo Simulations indicate all possible outcomes and probability of the outcomes of an investment.  

To learn more please call Wert-Berater, Inc. at 888-661-4449 or visit the company website at  www.wert-berater.com

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Wert-Berater provides all civil engineering, construction consulting, appraisal, feasibility study, and risk management services to lenders, investors, commercial and investment banks 888-661-4449