There is one rule to remember in commercial real estate whether you are a buyer and holder, or someone who makes money on the management side: financial value is judged on what can be made going forward, not what it was in the past.
The trick is to identify this potential and what can be done to build value going forward.
The following drivers are important to consider when examining potential value in commercial real estate:
1. Location. Location. Location.
Potential value will come from a high-traffic area with strong demographics, an area where new condos or subway line expansion are great examples. Being closer to transit or places easily accessed by walking is also attractive.
2. Revenue, cost and capitalization rate
People sometimes forget the cost of upcoming vacancies. Is there a major tenant about to leave? Any zoning and developing issues/trends? What else is coming up in the area? All this impacts capitalization rates, an important measurement of risk, so avoid thinking of a property in isolation.
3. Steady tenancies with strong tenants
Tenants that want to stay and pull people in are what make a property look good, demonstrating stable and predictable tenancy. The goal is to only re-lease tenants that are paying below market rent.
4. Strong anchor or shadow anchor to draw significant traffic
There is a reason there is usually a bank or large grocery store in so many plazas. Each property needs one big draw that brings people in and benefits other stores.
Being near a shadow anchor, a popular store not in your mall or plaza but close by, also adds value. Because anchors are used to negotiating great leases, they may not be the best place to find profit. Shadow anchors, however, can often provide better value, paying a premium to be near the traffic driving anchors.
5. Current leases below market value with short-term expirations and upside
A mall or plaza with leases about to expire can be very attractive if there is a good chance of putting a better, higher paying tenant in place. This is a good strategy for investors looking to pay less now with the intention of flipping the property for more money, as well as for those looking to keep and manage the property with increased profits.
6. Rent-driving retrofits
Upgrading the appearance of a property can be a quick value driver by helping find or keep better tenants and bringing up the scale of customers. Painting, replacing appliances and adding new food courts are cheap fixes with big return. The trick is not investing in upgrades that people won’t pay for. Reconfiguring a layout is another value driving idea, such as changing flow or creating a multi-tenant space where there was a single tenant by making more usable space.
7. Under-utilized footprints for future development
Parking lots are a great example of space that can be repurposed to include an entire new set of buildings, providing more places to rent. The ability to add more pads, adds value to a site.
Jeff Grad is president of Equitable Value, a firm that specializes in valuing properties for tax, financial reporting and acquisition across Canada. Richard Crenian is the founder and President of ReDev Properties, which owns and manages over 25 commercial properties, predominantly in Western Canada. Visit his website to learn more.
