The goal of investing is to receive the highest possible rate of return on each investment. The higher the return, the more you earn and the more the investment is worth. So how do you boost your commercial real estate rate of return for an investment property you currently own? Let’s take a look at six ways to boost your rate of return on a commercial property.
How is Commercial Property Valued?
To understand how to boost your rate of return on a commercial property, you must first understand how commercial property is valued. Since commercial real estate is an income-producing asset, the valuation of the property is not done by looking at comparable properties but instead by looking at the property’s net operating income (NOI).
This is the amount of cash flow the property produces after all income and expenses (not including debt service like a mortgage payment) have been accounted for.
Commercial real estate values a property using a capitalization rate, or cap rate, such as a 6% or 9% cap rate. Cap rates will vary based on the location of the property and the sector, but in general the higher the cap rate the higher the rate of return and the greater the discount on the property. The lower the cap rate, the more the investor is paying for the property in comparison to its income, thus the lower the rate of return they receive.
How is Commercial Real Estate Rate of Return Calculated?
The rate of return relates to the actual cash on cash return on investment (ROI) of a property, which is net income divided by the amount of money invested. The less money an investor has invested in a property, the better opportunity they have for an increased rate of return.
How Can You Boost Your Commercial Real Estate Rate of Return?
By far the best way to boost your rate of return is to put the least amount of money down as possible. However, there are other ways to boost your rate of return after the property has been purchased. An investor can also increase their rate of return by increasing the net operating income or rental income received each month.
The six strategies below are different ways you can boost a commercial property’s rate of return in one of two ways:
- By increasing the net operating income (or net cash flow) while holding the property.
- By increasing the rate of return when selling the property by increasing the property’s value.
1. Decrease Vacancy
When a rental property sits vacant, it loses money. Decreasing a property’s vacancy rate will increase your net operating income because you’re increasing the number of units or the amount of time the property is collecting rental income.
Most commercial real estate sectors have a standard or average vacancy rate based on the property type and location. So, while a 0% vacancy may be appealing, it’s rarely achieved when charging market rents.
2. Increase Rents
While every investor should aim to keep vacancy rates low, they should also strive to keep rents at or near market standards. Some investors, especially if the property is charging below-market rents, have the opportunity to strategically and incrementally increase rents. Nonetheless, rental increases should be done on a regular basis to match inflation and reflect changes in property-related costs such as property insurance, utility costs, or property taxes.
3. Decrease Expenses
Keeping expenses low is extremely helpful when trying to boost your rate of return. While not always feasible, there may be opportunities to decrease certain expenses, especially after acquiring a property that may have been poorly managed previously.
4. Add Additional Streams of Revenue
Creating additional streams of revenue can be a great option for helping boost your rate of return, especially in conjunction with the other strategies referenced here. Common additional revenues can include:
- Charging rental fees for additional space, such as parking or garage space
- Collecting late fees
5. Improve the Property
While improving the property may not always increase your rate of return, strategic improvements can add value to the property overall and allow for you to justify increased rents or help with getting new tenants. Installing new energy-efficient windows or air conditioning units could reduce your overall utility expense and increase your return.
6. Expand
If your property is currently performing to market standards, another option is to expand your property, adding more rental units. While this is not always an option, some investors target properties that have additional land solely for the opportunity to expand and add additional units, buildings, or rental space.
Final Thoughts
The bottom line when real estate investing is to get the greatest possible return. By utilizing the six strategies above, you can potentially increase your rate of return and boost the investment as a whole.
