When comparing sales in commercial real estate, having accurate and relevant information, especially with your real estate comps, can be a game changer. Before placing a bid on a property, you’ll want to understand the story and environment surrounding related transactions. Getting the right data might involve some upfront research, but the extra effort can help you gain an insider’s edge over the competition.
Note from Spencer and Michael: This is another post from our guest contributors and industry professionals. James Nelson is an investment sales broker and Principal and Head of Avison Young’s Tri-State Investment Sales group in New York City. He is also a passionate investor and has successfully launched two real estate funds with capitalizations over $350 million. He is passionate about helping others find success in the industry and has graciously offered to share his expertise with the A.CRE community. A huge thank you to James for offering his insights! Click here to learn more about James or contact him directly.
While there are many elements you can compare, in my 25 years of experience in the real estate industry, I’ve found several that are especially applicable. These include understanding the marketplace at the time of the sale, evaluating pertinent metrics, and knowing the conditions of the property. Let’s look at each of these and see how they can help you make the most applicable comparisons.
Understand the Marketplace to find the most applicable real estate comps
To get started, study properties that have sold in the past. Keep in mind that when sales are reported, they often reflect a transaction that was negotiated six months before. For commercial properties, it can take the buyer and seller a matter of weeks to agree on a contract. Once that document is signed, another 60 to 90 days may go by before closing. Sometimes a month passes before the sale is officially reported.
Given this, think of comps as a rearview mirror. The reported sales help you see what the market was like six months ago. As you review these, consider macro trends too. In June 2022, for instance, interest rates started to go up. There’s no doubt been a great deal of cap rate expansion since then, which means downward pressure on pricing. If you’re looking at comparable sales from early 2022, you’ll want to account for marketplace conditions at that time.
Find Price Per Square Foot
One of the easiest metrics to look for in comparable sales is price per square foot. This involves taking the price of the property and dividing it by the square footage. During this step, recognize that there are different ways to report square footage. In buildings, the usable square footage might be separate from the rentable square footage. In office leasing, this could have a loss factor, so you’ll want to check that as well. A marketing flyer could help you understand how the property was built and its square footage.
Calculate the Price Per Unit
For multifamily properties, it’s especially relevant to look at the price per unit, which you can generally find on public record. This involves taking the sales price of the property and dividing it by the number of units. If you pay $1 million for a 10-unit apartment building, you’ll spend $100,000 per unit ($1 million / 10 units).
In my experience, I’ve found that many buyers of multifamily properties look at both price per square foot and price per unit. These two metrics can help you make comparisons before you get into the financials of the building.
Investigate the Capitalization Rate to determine the most applicable real estate comps
This figure is found by dividing the net operating income of the property by its sales price. When evaluating, you’ll want to dig below the surface to analyze how the net operating income was calculated. Ask questions such as: Was it from a broker’s setup that used very light expenses? Were projections used? Were those projections actually accurate, or was projected rent pushed up to make the sales price look better? Was this a cap rate that was reported by one of the data collection services or in the press?
The number quoted is only as good as the credibility of the information used to get it. I’ve found that one of the best ways to get accurate financial data is to speak to the broker who is familiar with the transaction. You can also reach out to the buyer to understand the reasons for the purchase and cap rate.
One of the most important factors here involves the type of tenancy. A property with a national credit tenant could have a tighter cap rate. For a place with a mom-and-pop renter, it might be higher. It can also be helpful to look at lease longevity, meaning how much longer the lease will be in place. This is especially important if there’s perceived upside in the rent. You might be looking at a property with a 4.5% return. However, perhaps the tenant is a retailer and only has two years left on the lease. The buyer could be looking at a much higher stabilized yield on cost.
Review the Conditions of the Property
Did the property require renovations? Were capital expenditures made? This can be tricky to find out if you aren’t familiar with the property, but it’s critical to know. If you’re looking to buy a property that needs significant renovation and comparing it to a place that was finished and delivered turnkey, those are two very different assets. You’ll want to know your all-in price, including the money you invest and what it takes to renovate the property. Then you can compare that to the finished price.
As you can see, there are many considerations to take when analyzing comparable sales. When searching for information, remember that any publicly available data can be seen by all, including your competition. If you take the time to pick up the phone and call the broker connected to the transaction, you could get details to help you evaluate the pricing. The better information you have, the more it will give you the insider’s edge to real estate investing.