What Is a Good ROI in Commercial Real Estate?

What is a Good ROI in Commercial Real Estate

No matter how experienced you are in commercial real estate, there is always one question that investors ask: what is a good return on investment in commercial real estate? It may seem simple to answer, but there are many factors that Ullian Realty offers insight into.

 

What is Return on Investment?

Return on Investment (ROI) is a crucial metric used in commercial real estate to evaluate the profitability of an investment. It measures the return or profit from an investment relative to its cost. By subtracting the investment cost from the investment gain and dividing it by the cost, one can determine the ROI percentage.

ROI Illustration

Various factors impact ROI in commercial real estate, including property loans, interest rates, and maintenance expenses. A property with significant loans or high interest rates can reduce the ROI as more money goes toward debt repayment. Additionally, management fees and repair costs can lower ROI if they are substantial.

Investors employ various formulas, such as cap rates and cash-on-cash returns, to assess ROI accurately. Cap rates (or capitalization rates) measure a property’s expected annual rate of return based on its purchase price. Cash-on-cash returns compare the initial cash invested against the net operating income generated by the property.

In commercial real estate, there are two primary methods for calculating ROI: cost and out-of-pocket. The cost method involves subtracting all costs associated with acquiring and owning a property from its total gain. These costs include purchase price, loan fees, renovation expenses, legal fees, and other expenses incurred during ownership.

ROI vs. Profit

When considering the financial success of a property investment, it is important to differentiate between return on investment (ROI) and profit. While ROI provides valuable information about the percentage gain or loss on an investment relative to its cost, it does not directly indicate the actual profits investors will realize. ROI is based on the initial investment and the potential income generated by the property. Still, it doesn’t consider selling costs and other expenses associated with exiting the investment.

For investors to profit from their property investment, they must sell the property. However, selling a property can be a complex and costly process. Even if the property appraises at a specific value, it may not sell for that amount due to fluctuations in demand or unfavorable market conditions. Furthermore, various costs are involved when selling a property, including broker commissions, appraisal fees, marketing expenses, and transaction fees. Investors should consider these costs when determining the actual profit realized from an investment.

What Type of Property Offers a Good ROI in Commercial Real Estate?

One of the biggest variables to remember is that the ROI changes with each type of commercial property. According to Nolo.com, the average ROI on any commercial property is between 6% and 12%, but it varies beyond that. The type of tenants significantly impacts the ROI, and for good reason. Some commercial investors follow a portfolio approach to receive a higher ROI. However, in this scenario, you may be less connected to the day-to-day operations of the building.

Business tenants often maintain their space at a high standard to meet customer expectations. An apartment building is also a commercial property. However, it’s common to experience more wear and tear from tenants, which will require more upkeep on the part of the property owner. A manufacturing tenant will customize a space, and it’s common to make major renovations before a new tenant occupies the building. This can cut into the overall ROI.

Does Location Matter in Commercial Real Estate?

Location is everything! A town that lacks business development may have a slower return on investment. A busy city that is home to many industries will provide more opportunities, and tenants will pay a higher price for stability. It’s essential to ensure the properties you invest in are appropriately zoned for how you intend to use them and that they are easily accessible for tenants and customers.

Is the Highest ROI the Main Focus?

Regardless of the ROI on your next commercial real estate property, developing a long-term plan will always win over focusing on the highest paycheck. As you know, not all commercial properties appreciate over time. You may hold onto a property for 10 to 20 years, so having a plan and hiring the right professionals along the way is vital.

Working with a local broker is one of the best ways to help determine your commercial property ROI. They will know the details of the area and market trends much better than anything you will find online.

Contact Ullian Realty in Brevard County, FL, if you want to invest in properties on Florida’s Space Coast. With over 50 years of combined experience in Brevard County, the Ullian team is ready to answer all your questions and help you determine which properties are best for your investment goals. Give us a call today.