How to Underwrite a Commercial Real Estate Deal (Step-by-Step)
Would you buy a $400,000 commercial building if the bank told you to bring an extra $27,378 to closing? That's exactly what happened in this example. In today's Office Hours, I'm breaking down how to underwrite a commercial real estate deal from start to finish using a 4,000-square-foot retail strip center. We're going beyond the asking price and advertised cap rate to look at the numbers that actually determine whether a deal works. Here's what we're covering:
How to evaluate a commercial property using its actual rent roll
Why advertised cap rates don't always tell the full story
How vacancy and triple-net (NNN) reimbursements affect your income
How to calculate net operating income (NOI)
Why debt service coverage ratio (DSCR) determines how much a bank will lend
How to calculate cash flow and cash-on-cash returns
How to work backward from the financing to determine your offer price
The numbers: A $400,000 building advertised at an 8% cap rate actually produces a 7.49% cap rate based on its current income. That difference reduces the available loan from $280,000 to $252,622. The takeaway?
The rent roll sets the price. The coverage sets the loan.
Whether you're analyzing your first commercial property or looking to sharpen your underwriting skills, this walkthrough will help you approach your next deal with more confidence.
Key Takeaways
Understand the Four Core Numbers: Learn how income, expenses, net operating income (NOI), and cap rates determine a commercial property's value.
Underwrite Actual Income, Not Potential: Base your analysis on current rent collections and occupancy rather than projected income.
Verify the Numbers Before Making an Offer: Review rent rolls, leases, operating statements, property taxes, and insurance quotes to avoid costly surprises.
Account for All Operating Expenses: Include management fees, reserves, maintenance, and vacancy costs to calculate an accurate NOI.
Understand How Cap Rates Impact Value: Learn how tenant quality, lease terms, property condition, and risk influence what investors are willing to pay.
Create Value Through Strategic Leasing: Discover how filling vacancies and increasing NOI can significantly increase a property's value without major renovations.
About Your Host:
Tyler Cauble, Founder & President of The Cauble Group, is a commercial real estate broker and investor based in East Nashville. He’s the best selling author of Open for Business: The Insider’s Guide to Leasing Commercial Real Estate and has focused his career on serving commercial real estate investors.
Tyler Cauble
Whether you're transitioning from residential real estate or you're just getting started in commercial real estate, underwriting is is very different from residential, and it's one of the most important things that you can do as you're going through the process of buying commercial properties. There are four numbers that you really, really need to look for, and it's it's very important that you understand this process the right way because you can look at a deal and have a gut feeling that it's a good deal, but the nice thing about commercial real estate is that you can verify that mathematically. Like you can actually go through the numbers and make sure that the deal is not just a good gut feeling deal; it actually works, and that all comes down to the underwriting and how you actually analyze those numbers. The fun thing about commercial real estate, and many of you know this if you've been following along for a little while, is that $1 of income is worth quite a bit of money when it comes to forced appreciation in commercial real estate. That is not something that you get out of residential real estate, right? Because on rental houses, your value is based on comps, right? So it doesn't matter if you're able to rent for 50 or $100 a month more than your neighbor. If your neighbor has an identical three bedroom, two bath house and they decide to sell it for $50,000 under market, unfortunately, they've just set a new comp for what your house is probably going to be worth, whereas in commercial real estate, it's all based on the net operating income, right? So, at an 8% cap rate, $1 of annual income is worth $12.50 in value. That's a pretty substantial difference, and that's one of the things that I love about commercial real estate is that you can actually create the value? The work that you put into it generates the value instead of what your neighbors sell for or just where the market is headed. You can actually control what your building is worth. Now, there's three habits that I see because we we work with residential investors trying to get out of residential and moving into commercial real estate all the time, and three habits that I typically see them going for almost immediately when they're first making the transition, they go looking for cops. And yes, of course, you want to look for cops in commercial real estate. That's not necessarily what I mean. I just mean that they are not. You do not in commercial real estate base the value of your building off of what sold next door, necessarily, it could be if the building is comparable, but it's not going to be the same as it is on the residential side. I'm in a three-story office building right now, 28,000 feet. We bought it in 2019. Next door is a motel. If that motel sells for $150 a foot, that doesn't necessarily mean that my building is worth $150 of flood. All right, it's based off of what this building earns compared to what that building earns. I see residential investors a lot of times thinking in terms of gross rent, which makes sense because the leases that you're signing they're gross leases, right? It's just the nature of the beast. Unfortunately, you can't sign triple net residential leases, and hey, when if if and when that ever becomes legal, I might start looking at residential housing as a as a potential. Still, probably too much of a headache considering the amount of money that you'll ever make on them. Because look, I mean, what is it like 100 to $250 a month net that you might make on a residential house these days. I mean, if an HVAC unit goes out, you've lost over a year's worth of rent. It's just not worth it to me. But the nice thing is, in commercial, a tenant is actually paying you or reimbursing you for the property taxes, the building insurance, and the commonary maintenance, like the landscaping and you know lighting in the parking lot, stuff like that, which is pretty nice, and then of course the lease terms. I'll see a lot of residential investors trying to go for one to three year leases, which I totally understand why. But most businesses want five years.
Tyler Cauble
They'll they'll typically look in that three to five year range, oftentimes longer, and that can be scary for a residential real estate investor because they're like, "Oh, okay, well, but what if, what if rents go up substantially next year? Well, there are triggers in your commercial leases that you can set up that either increase the rent annually automatically, like you're agreeing to that on the front end, 3% to 5% annual increases. That way, it's at least keeping up with CPI, maybe not CPI in the past few years, but that's typically market is three to 5% annual increases. You could also tie it to CPI, so whatever the CPI index is, that's how much your rent goes up. You could tie it to all sorts of different things that you want to. You could reevaluate it every single year and reset the rents if you want. I don't like doing that because then it just means more work. I like to set it and forget it, so that's why we go for 3% to 5% annual increases, and we go for five-year leases. But you'll have tenants that will sign 1015, 20-year leases. We're working on a deal right now where the tenant's going to be signing a 20-year base lease. 20 years. There's a lot that we have to take into account there, but it's a very specific custom build job for for that tenant. Okay, so I mentioned earlier, underwriting is for numbers. That's really all that it is in the basic terms. You guys have heard me say quite a bit on the show. Commercial real estate isn't easy. It's not, but it is very very simple. What you are going for when it comes to underwriting commercial properties, the income, right? So how much money is it going to be bringing in this year? That includes your base rent. That includes any additional rent. That includes any tenant reimbursements for you know CAM taxes and insurance. All right. What your expenses are. So every dollar that it costs to run this property, whether or not you are paying it or not, right. So if you're getting reimbursed for those expenses, you're then paying them, so they typically wash out. All right, on your profit and loss statement, the net operating income that is your income minus the expenses, very straightforward, right? And the NOI is what ends up valuing the property based on a cap rate. That's what every investor is looking for: is what is the net operating income, and then of course the value. Right, that's the NOI divided by a cap rate. The cap rates can be determined by comparable types of assets in the market. Now, I get this question a lot because cap rates can be very nebulous. Who who determines what the cap rate is? So there's kind of some guidelines for you to follow, but also it's a little bit of like what is the market willing to pay. Now, if you're signing a lease with a corporate credit tenant, let's say it's a Starbucks. They're signing a 15-year deal, and it's corporately guaranteed. Well, you can go on the market and you can see, okay, well, every brand new Starbucks that is trading, you know, today is worth a five, like a 4.75 to a five and a half percent cap rate, and you can get pretty close because there's so many of those trading. You get pretty close to what that cap rate is actually going to be. Now, if you're going for something that's maybe it's a national credit tenant, but they've got two years remaining on their lease, well, you're probably not going to pay a 4.75% cap rate for that. It might be closer to a 6% or 6.25% cap rate. It kind of just starts to depend on where your market is. Generally, what I tell the Accelerator Mastermind members is, if you're going for like local or regional credit deals, which is what most of us are doing, all right, you're looking at like seven to 8% cap rates on those deals. So that means if like I have a three-tenant strip center. I've got the dry cleaners. I've got the local bar, and I've got a you know say a barber shop, and they're all on five-year leases. They're they're decent credit.
Tyler Cauble
You know, I mean they've got decent financials for local businesses, but it's not like we're signing a corporate guarantee. You're probably going to be seven to seven and a half percent cap rate. If you've got shorter lease terms on those, you're probably pushing an eight. Anything above an 8% cap rate generally means that there's a lot of risk. There's something going on. There's something wrong. Maybe you've got at least turnover. Maybe the building has a lot of deferred maintenance. So again, kind of nebulous, but that should give you at least a guiding light, a north star to follow when you're first diving into the numbers on a commercial property, there are five things that you really need to ask for or to go gather yourself before you start. You cannot really build the first underwriting draft without them, and that's one thing that I do want to reiterate to you. Your underwriting is never finalized. It's never finalized. It's it's a living, breathing document that you will update as you gather more data. All right, so you continue to pull in all this data. First is the rent roll. If the building has tenants, who are they? What are they paying? What are their lease terms? What are the, you know, specialty lease considerations that you need to keep in mind as you're buying this? That will give you a pretty good overview of what's going on in terms of rent collections on the building, and you know your your expense reimbursements and things like that. Then there's the leases themselves, right? Rent rolls are great, but there are plenty of times where sellers can be intentionally or not deceitful on their rent rolls, right? Maybe the rent rolls just not updated. Maybe there's something that's not actually accounted for in the rent roll that is in the lease. And I'll tell you this for a story of one of my buddies who bought a building. They had a one cent. They had one sentence in their lease. It was like a 30-page lease of a deal that they bought. One sentence towards the bottom of one paragraph on like page 23, right? That said, hey, every November the tenant doesn't have to pay rent. Well, the base rent, everything else, like on you know paragraph four. When it talks about what the rent is, says, "Hey, here's the monthly rent they pay every month. But then later on in the lease, it says tenant doesn't have to pay rent in November. That's a big problem if you're counting on rent coming in on november 1. So make sure that, like, yes, you want to verify the rent roll, but you got to verify that according to the leases. The leases are the contractual agreement that will dictate how everything is handled. Okay, you want to ask the seller for 12 months of operating statements, or the broker, whoever you're talking to. Those, if a seller doesn't have the actual costs of running the building, that's a big red flag to me. They should have that because they are they own the building and they have been running it. They should either have that in a profit and loss statement. They should have it through tax returns. There there are plenty of ways that this can be verified because I'll have I'll have you know like clients or students that'll that'll say to me like oh the the seller doesn't have you know operating statements that they can hand over. Well, they have something. There's got to be bank statements. Like ask for 12 months of bank statements. There has to be something that shows that what the actual operating expenses are on the property. Because one, like anybody, regardless of how sophisticated you are, they're going to want to write that off on their taxes. That way, they're not paying taxes on the gross amount of rent collected, so they're probably accounting for it there. They probably have it in their QuickBooks. They probably have it, you know, either a bookkeeper or a CPA is keeping track of all of this. It's got to be somewhere, right? So, so ask the seller for that. The tax bill you can get that from your local assessor's office if the seller is not able to give it to you, sometimes sellers just don't know. They'll get you know it mailed to them.
Tyler Cauble
They just go on and pay it, and so they don't necessarily keep a record of it. But you can actually get this online too, so you can see what the tax bill will be. I always tell clients as well, like make sure that you are looking up what your millage rate is and what the assessed value as, and how all of that is going to work with the new purchase price, because what the seller is paying in property taxes today is not what you are going to be paying when you buy it, unless you buy it for the exact same price as what they paid for it, and there's no reassessments and nothing has changed with the millage rate and all that kind of stuff. All right, so make sure that you are accounting for that because if you if you input the wrong property taxes, you're going to have wrong underwriting. All right, and then of course your own insurance quote. Okay, insurance is one of those things today that it's gone up substantially. If somebody's had a property for a while, maybe they've been grandfathered in with lower rates. Maybe they haven't, you know, been moved up to today's rates. Your rates are probably going to be higher, and almost everybody looks at insurance differently. Like you can have, you know, two people that are looking at the same property that will put different levels of insurance on it for different reasons, which means that your premium is going to be different. They may not be covering it as much as your bank is going to want you to cover it, they may not be cover. They may be covering it more. So that's something that you'll definitely want to take into account as you're getting into those numbers. So I'm going to walk you guys through an example 4000 square foot strip center that has four units on it. Okay. So step number one, let's dive into the income that exists. This is not the income that the building could produce. All right, that is a big mistake I see in underwriting all the time, and that's what brokers and sellers want you to underwrite a deal on. Right? Here's what it could do. Okay, mr. Seller. Well, one, I'm not going to pay you for tomorrow's price today, and two, if it's that easy for me to get to that rent number, why don't you just do that and capture the value? Because if they're going to tell you, oh well, it could be making $20,000 a year more. It's like, okay, well, if $1 of NOI adds $12.50 in value on an 8% cap rate, $20,000 of net operating income additionally a year is a lot of dollars that you could be pocketing yourself. Why have you not done that? It's a great question to ask. Okay, so four units. These are 1000 square feet each. So that's 4000 square feet. Our asking rent is $12 per square foot, which means if all units released, that's $48,000 in base rental income a year, but if we only have three out of four of those units leased, we're looking at about $36,000 a year. So that $12,000 is an empty unit. You are not actually collecting that. That is your expected gross income, but that is not actually your effective income. Okay. Step two: the line that houses do not have on a lot of commercial leases, the tenant is paying the building expenses back to you. They are reimbursing you. Now, generally, this is done through an estimate of what the overall expenses are going to be for the entire year, and you break it out, and they pay you one. 12th every month, right? So they pay you, you know, monthly for what that share of their property taxes, building insurance, and common area maintenance is going to be. So let's say on this building it is $9,000 because you've got only three tenants that are reimbursing you for their share of a $12,000 expense pool. So one thing to keep in mind: if you have triple net leases, that doesn't mean that you are just always going to be free of not having to pay CAM tax and insurance.
Tyler Cauble
If you have one tenant move out and they occupy 25% of the property, as in this example, you are now responsible for that 25% of CAM tax and insurance for as long as it is vacant. So not only are you not collecting the rent, but you are now having to pay the expenses for that share of the building. All right. So the building collects $45,000 a year, not 36,000. So remember that $36,000-that is your base rent, plus the $9,000 in CAM tax and insurance reimbursements. That is how triple net leases are actually structured. Step number three: take all of the expenses, not just the seller's expenses. You want to account for what the actual expenses will be on the property. Some of the stuff that I see very commonly, and we've got this accounted for here on the slide: management, property management. You'll see a lot of sellers that are self-managing. All right. Well, if a seller is self-managing, they're sometimes they don't charge themselves a property management fee. Well, just about any sophisticated real estate investor is going to charge a property management fee. If that seller gets hit by a bus, somebody has to step in and manage the property. You're going to have to pay for that, so you might as well account for it. So, we've got taxes, insurance, and maintenance at $12,000 a year. We've got property management, which is 5% of our total collections. So that includes your base rent and your common area maintenance taxes and insurance, right? Your triple net expenses. So you're charging 5% on everything, so that's 2250 a year. Reserves at 25 cents a foot come out to be $800 a year. So your total operating expenses are $15,050. All right, if you leave out the management fees, if you leave out reserves, and you don't subtract those from the net operating income. Let's just assume you're going based off of what the seller is actually giving you. You could overpay in this scenario by over $38,000. Now, in the long run, maybe over five, 710, years, maybe that's not a huge deal. But do you want to overpay by $38,000 if you don't have to. You have a good argument with the seller that your your net operating income isn't real because you were actually investing a lot of your time every month in dealing with the tenants, collecting rents, you know, managing the landscaping. That you know really is is going to have to come out of the bottom line somewhere. Step number four, you calculate the net operating income. So we take our our base rent plus our reimbursements minus our actual expenses, and that puts us at $29,950 for this example. All right, that is everything the building collects minus everything it costs to run before any loan payments. All right, so your net operating income is above the asset level expenses, so you're not paying any loan payments out of that net operating income, or at least you're not counting the value of the property based on what the debt's going to be. The reason that's done, you might pay cash for it. I might bring 50% debt. He might bring 100% private money at 12% That doesn't mean that that should change the value of the building. That's just how everybody's you know financing structure is going to be different. Okay. So step number five, you turn that income into a price, and I'm going to run you guys through here in a minute our deal analyzer. It is the underwriting calculator that we have put together. We used to use spreadsheets. This is far more sophisticated and way easier to use. Like typically, when when an underwriting spreadsheet is more sophisticated, and I've seen some crazy ones, like like national development companies that we have worked with on selling land to them or coming in to to develop multifamily, I've looked at these spreadsheets, and I'll tell you, like I've been doing this for 13 years. It takes me 2345, hours just to wrap my mind around how their spreadsheets work. Then I have to get in and actually start running through it to make sure that they're accounting for everything properly. Okay, the deal analyzer just takes that completely away, which is really cool. So that net operating income at a 7% cap rate values the building at $428,000, give or take. All right.
Tyler Cauble
That's assuming again a 7% cap rate. You've got maybe some brand new leases with local credit tenants. The building is fixed up. This is a relatively turnkey deal for a local investor. All right. At an 8% cap rate, that puts you at $374,000, give or take. That's probably a little bit more of like that's probably a higher cap rate than I would expect a lot of these strip centers to to trade at. But maybe you've got a vacancy. Maybe you've got some leases that are ending the next two or three years. Maybe you've got some deferred maintenance. The building's just not going to be worth as much as it is. The big thing about cap rates is that investors are willing to pay lower cap rates for deals that they don't have to worry about and don't have to do anything for. All right, so it's really a a measure of the risk on any given deal. The same building could go for a 5% cap rate and an 8% cap rate, depending on the tenant, depending on the lease structure, depending on the conditions. It could be identical in almost every single way, except for if I've got you know Starbucks versus Joe's coffee shop. That's going to drastically change because an investor is going to look at Starbucks and go, well, I know that they're probably going to pay their rent for the next 15 years, and I don't have to worry about it. Whereas Joe's coffee shop, I mean, he might sell. He might decide to close one day. He might get tired. Who knows? At a 9% cap rate, a buyer is pricing in risk, right? Or maybe it's a weaker property. It's a weaker side street. You don't have the traffic coming in. It's maybe the parking isn't as ideal, right? So that would value the building at about $333,000. This is the same building, same income. We're talking about a difference of $95,000 depending on how it's underwritten, and the underwriting comes down to what is actually in place with this property, and so that's why it's really important if you're getting into commercial real estate that you you strategically think through how you're going to set up your leases, the types of tenants that you are going for, because the difference between a coffee shop with five locations and a startup coffee shop could cost you a couple of basis points on your cap rate, right? So even though you might be leasing to the coffee shop with five locations for a little bit less because they're better at negotiating and there's more leverage there for them, you might be able to get a lower cap rate because of that lease, which means you actually might get more value out of it in the long run, so definitely something to keep in mind. Now here's the part that changes everything: $178,125. That is what leasing the one empty unit is worth. So if you buy a 75% occupied building, if you buy this 4000 square foot strip center, and you sign one lease, it adds $14,250 of net operating income to the property, and the income is what the value of the property is based on. You could sign that lease, do nothing else. Sign that lease at $178,000 in value and sell it the next day. And I've done this before. We we had a deal where we went under contract. We were buying a vacant strip building. It was probably 2200 square feet, so vacant. We bought it for $435,000. We went under contract for $435,000, and this is in East Nashville, guys. So, like, y'all can go find deals like that in your market that are, you know, basically the same price as a house. Here's what you can't do on a house, though. We signed a lease before we closed. The bank appraised it based on the lease For $650,000. So day one, the bank said, "Hey, because you signed a lease, we didn't do anything else. We didn't even invest any money into it. It was now worth $650,000. We turned around and flipped it for 625. So almost $200,000 in value created just because we signed a piece of paper. That's what I love about commercial real estate. So, here's what you do with the answers once you come to your final, you know, numbers on the underwriting.
Tyler Cauble
One, you know what to offer, right? You know the risks that are involved in the deal. You've accounted for what the actual income is going to be. You can actually account for what your true cash flow is going to be if you're going to be looking at these deals the right way, and look, maybe you're a math savant, but I can't do all this stuff in my head. That's why I have to use the deal analyzer for every deal that we do. And maybe you just use a spreadsheet and you just kind of keep track of things on there, and that's totally fine too. But you want to make sure that you're at least writing all this stuff down and thinking through what all of these different scenarios and different expenses and different rent collections will be all right. Based on these numbers, you'll also know what a bank will lend. It will give you more leverage in having conversations with lenders about how much they should give you because you will know what the debt service coverage ratio is. You will know what the property is going to be worth when you're done. You'll have all of the numbers that you can actually. Hand over to a bank and make it far easier for them. They're going to underwrite it anyway, but if you have compelling underwriting, they might be willing to listen to you a little bit more. That's why you know when we underwrote that 2200 square foot building, they were willing to appraise it for $650,000, and we you know had to bring very little cash to close on that one because of it, because they said, "Well, there's $200,000 of equity already in this $650,000 deal. We still want you to have some skin in the game. So I think we ended up bringing like I don't know 100 grand, maybe. It wasn't even probably that much, and it was pretty great. You know, it's pretty nice to be able to work out deals like that. And then of course you know where your returns are coming from right. So if you've got an empty building, the rent on that, you know, on the other three that are already full, you know what's coming in, right? So you know, like, hey, let's make sure that we keep those leases in place. Let's keep those tenants happy, so that those that rent's coming in. Let's find a way to replace the vacant income. So those are the four numbers that you know, like at the most basic level of underwriting, what you are accounting for. That's what you want to be diving into and making sure that you are fully accounting for as you are going through the underwriting process. And here's what I want you guys to take away from this. And after this, I'm going to show you guys like everything that we account for in the deal analyzer, because there's a lot of numbers that if you don't think through, you're going to buy the building wrong. A house is worth what's sold next door, but a building is worth what it earns. You cannot control what the house next door sells for unless you own the house next door and you're selling it, but even then, it's going to sell for what the other house down the street sold for. A building is worth what it earns, and that is something that you can actually control. And that's what I love about commercial real estate: is that I'm not utilizing hope as a strategy. I'm not hoping that my neighbor, you know, takes all those junk cars out of their driveway, fixes it up and sells it for enough to where my house is now worth more. I can just go in, fix my building up, lease it for more, and then value it based off of the income that we are creating. So, with that being said, let me pull up our deal analyzer. I'm going to run you guys through just a high-level overview of what we actually look at as we are getting into these deals. So this is the deal analyzer. You guys can get a free demo of it, like a full demo of this entire software suite. By the way, if you want to go to crecentral.com/pro. Right, you'll be able to get the the demo.
Tyler Cauble
But if I click expand inputs here, and I go to full mode because we're not just going to look at back of napkin. So property details we take into account the building square footage, the year that it was built, the acquisition date because that will matter. Our purchasing costs. This isn't just the purchase price. This is what is it going to cost us to actually rehab these deals. Your closing costs you need to account for that because it's you know the purchase price and your your rehab is not the total price. You're going to have to pay your closing company money. You're going to have to pay your lender. You know their their loan origination fees, which we'll get to here in a second. There's other expenses that are involved as you're going through this. That again, if you're not thinking through it, if you don't have all of this organized and laid out, you might forget it. Then of course your down payment. Now once we get into financing, you've got the loan-to-value, interest rate, amortization, loan term, loan origination fee. But then we also get into some things that I see people forget about all the time. What's your lender holdback or escrow reserves? Is your lender going to say, "Hey, you've got to put $20,000 into a bank account just to hold it here so that we feel good about it" What's your minimum debt service coverage ratio? If you're not accounting for that in the underwriting process, you might miss what the bank is going to call out first. You want to make sure that the underwriting actually works for what the debt service coverage ratio the bank is going to be looking at will be. Operating capital reserves. Will that vacant space? Do you need to bring money to the table to cover those expenses, or are you going to account for that out of the rent that you're collecting? Either way, it's going to hit your cash flow. So something to keep in mind. I mean, we get into things like what what are your lender-funded soft costs? Are they? Is the lender going to fund all that for you, or do you need to bring the cash to the table for that? Do you have an interest-only period? Do you have any deferred loan payments? Are you going to be refinancing this property at some point? Do you have any subordinate debt? I'm starting to see this more and more today because we've got a lot of people that are working on creative deals, considering where the market is. I mean, interest rates are well over 7% again. So you know maybe you're getting the seller to carry a portion of the purchase price back, so you've got a senior loan, then you've got a seller carry, and then you're bringing your equity to the table. We got to make sure that you're accounting for what those numbers are actually going to look like. Then we get into the rent roll, right? So, who's the tenant? How much square feet do they occupy? How? What are they actually paying in base rent? When does their lease start? How. How long is it? What are your annual bumps? Are there any tenant improvement allowances? Are there any leasing commissions? Are you giving them any free months if you're, you know, renting a new space? Then we take into account our second generation assumptions. Once that tenant leaves, or once that tenant's lease terms up, they may not stay. They might leave, which means I need to account for how long is it going to take for me to to find the next tenant? What am I going to have to pay for commissions and tenant improvements on that one? What will they pay? How big of an increase will it be over the previous term? Of course, our operating expenses. We look at whether they're triple net or or just you know full service or modified gross. Is that based off of you know an actual number that we have, so I'd go in to show the detailed line items. You can see everything that we'd be taking into account here: insurance, property taxes, trash removal, utilities, management fees, payroll, repairs and maintenance, janitorial, landscaping, pest control, security and access, advertising and marketing, contract services, and then miscellaneous.
Tyler Cauble
And I've got even more like custom line items that I can add in here because sometimes, like you'll notice, I didn't have snow removal. Well, if I'm in the Northeast, I'm definitely going to have to account for snow removal. Management fees, asset management fees, capital reserves, cost segregation. Like, what are our tax benefits going to be here? What are my exit assumptions? You can see there's just so much that actually goes into these deals. It doesn't have to be complicated. It can actually be very, very straightforward as you're going through and underwriting the process if you have everything organized. Okay. So again, if you want to test it out, you can do it. Use the tool for free. Crecentral.com/pro. You can also just create your own Excel spreadsheets if you want to. But I like to make sure that everything is organized. That we're doing the same thing every single deal because that's how we start to create consistency, and that's how I start to notice anomalies in the deals that I'm underwriting. All right, let's get to y'all's questions, comments, concerns. I made this. I said this on the on the call last night. Any jokes? Anybody have any jokes that they want to share? Feel free to share those. Jason is saying good morning, sir. Jason, good to see you, man. He's one of our accelerator members. He's one of he's saying I'm one of Tyler's students. Please send me your commercial or residential deals that you need help with. Let's JV guys. Jason is based in Florida. He's got a lot of stuff going on, so feel free to reach out to Jason. He's buying commercial flex parking lots, industrial land of any size. He also buys residential, but we're not gonna we're not gonna fault him for that. All right, he's recovering. We're we're moving him more and more into the commercial space. Cherry is saying, "I live in Virginia Highland in Atlanta, one of the most one of the first walkable neighborhoods in the city, and many other suburban markets copy our walkability. People don't want to spend all their time in cars. Earlier in the show, I mentioned Atlanta and just how how gorgeous it is sometimes with the way that they've set their you know strip malls and and shopping centers behind the trees, and that's really cool, Jerry. Like Atlanta's got some really really beautiful neighborhoods, and I love the walkability there. Oh, this is hilarious! Jason had already said, as a recovering residential investor, I have a question. I use hard money frequently. I don't hear much hard money talk in commercial. Does it make sense to flip a warehouse with hard money? Absolutely. I've got a good buddy of mine here who actually started a private money lending company that largely focuses on commercial because I only know a couple of hard money lenders that focus on commercial. There's just not a lot of them. The numbers tend to be a lot bigger, right? So, like, if you think about flipping houses, maybe they're lending 250, 300, $400,000 on a house. Well, commercial, like I, I closed on Salt Ranch, our boutique hotel, in hard money because I had to close it fast in order for us to actually get the deal, and then refinance within a few months into a a like senior position bank loan. Well, that was like over $2 million, you know. So it's you've got to find the right private money investors to do that kind of stuff, but yeah, absolutely. That's why underwriting is so important. It will tell you whether or not private money actually will make sense to use because you're paying points, you're paying a higher interest rate. But if you're able to get in, close on the deal fast, get get everything you know renovated, get tenants in there, and you feel comfortable with your timelines going through all of that. Absolutely, it can make sense to do. Biggest thing that I always say about utilizing private money in commercial real estate, and I'm sure that this applies to residential as well. Make sure you have 17 exit strategies, because the last thing that you want to do is for that private money to start accruing at 12 to 13% interest, it can very quickly eat away your cash flow.
Tyler Cauble
All right, but it can be a phenomenal tool if it gets you in there quickly. You don't have to go through the whole rigmarole of getting you know a traditional bank loan approval. I mean, the way that I always talk about debt, and this really really applies to private money, is. It's like an ax, man. You know, if if you really know how to use an ax, you can cut down a tree very quickly. If you don't know how to use it, you might chop off your foot. So something to keep in mind. Jason is saying, when do you use hard money the most frequently? I have a lead that is a light flip, $125,000. Timeline of nine months. What are the advantages and disadvantages of this financing. Funny enough, I think I probably just covered a lot of that. I would say the biggest disadvantage is just how quickly it can accrue in terms of what your actual payments are. And then the other thing that I found too, like not all private lenders are like this, but they tend to be more like this than traditional banks, they are a little bit more ruthless. They don't mind foreclosing on you and taking the property away, whereas traditional banks, they typically don't want that property back. They want you to finish the project and figure it out. So, just something to keep in mind is the the private money winners. They're not necessarily always on your side. Okay, Trevor is saying, with interest rates being as high as they are right now, do you think it's a bad time to start investing, or are there still good opportunities out there? Trevor, great question. Here's what I say to that: You can always refinance out of a bad interest rate. You cannot refinance out of a bad purchase price. If you are able to leverage today's interest rates to get a better purchase price than you would if if and back and when interest rates were lower, absolutely, it's a great time to buy. I mean, I I believe that there's always a good time to buy commercial real estate. It's always a good time. It just depends on the specific deal that you're negotiating. If you're paying the same price today as you would have four years ago when interest rates were 3% lower, then no, I think it's probably you're probably looking at some bad deals. But if you're able to leverage that 3% delta in interest rates to negotiate a much lower purchase price to where it works at today's interest rate, then you just think, okay, 234, years from now, maybe we have to we have to survive for now. But when interest rates lower, I can either refinance and we will cash flow substantially better. I can refinance and pull more cash out and keep my debt service coverage at the same level it is today, and and cash out a little bit tax free, or I'll be able to sell it and the buyer will have lower interest rates, which means they can justify paying more for this building. So, absolutely, I always think it's a good time, and we were still we're still actively on the hunt for deals. Jim is saying I've been running leases through ChatGPT to have it identify the good, the bad, and the ugly items in the lease. Also, if it is multi-tenant, I have AI compare the leases to see what is the same or different. 100% I think that you could also have AI put together what are called lease abstracts. So those lease abstracts are basically like, hey, here's the major items that you will need to know about this lease. Like, you know, the the insurance clause, whatever. Like, that's probably the same in every single lease, not a big deal to worry about. But again, a lease abstract would pull out like, "Hey, by the way, every November that tenant doesn't have to pay rent. Important for you to know, very, very important for you to keep in mind as you're going through that process. So yeah, I mean, look, AI is not the end all, be all. Are we using it in our business to work on these deals? Yes, but always verify, right? I look at it as like it is a it is a entry level analyst in our company.
Tyler Cauble
If I hired an entry level analyst, I'm going to review their work and then I'm going to double check it myself. I'm not going to take what they are saying as you know the the word of God. All right, you've got to make sure that you're double checking it because AI makes mistakes too. Jason is saying he's got three units on one electric meter. Can I charge cam charges? How do I calculate and divide the charges? If so, by square foot. So, Jason, electric electric meters can be tricky when it comes to subbing those out. The best thing to do would probably be to get sub meters, right? If you're allowed to do that, typically, you know, it depends on your municipality. Like in Chattanooga, we're not allowed to like quote unquote resell power as a landlord because we are not licensed power providers, I guess, and so you know we're not allowed to like just turn around and build the tenants for power if they're all on the the same meter. It's just it's kind of funky, but you'd be surprised at how many municipalities are actually set up that way. So the best thing to do is to submeter them. It will cost you money, or maybe you can just set them up on a flat rate fee, something like that, where they're just paying you every month. You could do it by square footage, but what gets tough there, and why I like sub metering better, is that the the woodworking shop that occupies 1000 square feet could use 10 times the power. Of the 10,000 square foot office space next door, so it totally depends on how they are utilizing the power. Now, if every tenant is the same, they're all offices. Then yes, you could look at you know doing it on a per square foot basis. But I would make sure to look up like how your like what is kind of standard in your market. Jason saying, "FYI, the deal analyzer is amazing. It's a game changer for a newer investor. Takes all the guesswork out to give me an accurate overview. Appreciate it, Jason. It's been a fun tool to have, and we spent a we've spent I don't know a lot of time developing that tool. We've we've tested it on over 11,000 deals at this point, and what's pretty cool is that, on average, deals are being underwritten in less than 10 minutes. Like that's how simple it is to use. That's a pretty big deal. All right, AutoZone is saying, "How would you determine the market value of an office building that has been vacant for the past four years? I'm considering purchasing it and occupying part of the space. AutoZone, that's a great question. So, in that scenario, you would look at a couple of different things. One is is replacement cost, and then a discount to replacement cost, right? So, if you're going to build, if you're going to buy the land, and then build that office building brand new today, what would that cost? And then you would back into what a discount would be, since it's you know obviously not being built today and not brand new, that would basically give you like your your max price, right? Which obviously you're not going to pay that because it's not brand new. In that case, you actually would look at per square foot comps because you don't have any net operating income, you don't have any rent, you know, that you could actually throw a cap rate onto and value it in any other sort of way, so that's what I would say is is you are going in, you're valuing it on a price per square foot basis. You can look those comps up in your local tax records to to help determine what that value is going to be. All right, guys, appreciate you all for joining me on this week's office hours. If you enjoyed this, feel free to like, subscribe, leave me comments with any questions you all have, topics that you would like for me to cover in future episodes. Always enjoy spending my Tuesday mornings with you. We will see you next Tuesday at 830 a.m. Central Standard Time. Cheers.
Tyler Cauble
This episode of the Commercial Real Estate Investor Podcast is brought to you by my CRE Accelerator Mastermind, where you'll get access to my step-by-step investment blueprint, essentially a library of resources on how to invest in commercial real estate. You'll get connected to a supportive community of other commercial real estate investors that are doing projects just like you. You'll get personalized coaching and feedback from me every step of the way. Go to www.crecentral.com to learn more.