As of 2021, the commercial real estate market in the USA was estimated to be around $9.5 billion. The real estate market is forecasted to reach $14.6 billion by 2030. Accordingly, it is safe to say that now is the best time to invest in commercial real estate. However, you would need to know how to determine the profitability of real estate before making any investment.
According to Forbes, you could lose money in real estate only if you sell in unfavorable conditions. However, according to us, another way you could lose money in real estate is by investing under unfavorable conditions.
Knowing when to invest in commercial real estate and calculating the profitability of real estate is part of the job. You can get help from Robert DeFalco Realty, which has experts that can help you find the most profitable commercial real estate. Here are some ways they calculate the profitability of real estate.
5 Ways to Calculate the Profitability of Real Estate
Commercial real estate’s profitability is reffered to as the profit potential. It refers to the revenue your property can have after the expenses. However, the profitability of real estate is not guaranteed and can change. There are many risks involved when investing in real estate.
Below are some methods on how to calculate the profitability of real estate.
1. The Cost Approach
The most basic way to determine the profitability of commercial real estate is by using the cost approach method. For this, you will need to consider the cost of rebuilding the entire structure. This involves construction materials and other replacement costs. Additionally, you will need to compare the price with the property’s current value.
In this approach, you consider the total of the abovementioned costs and put them equal to the profit you will gain. However, this approach is only for new commercial real estate and does not compare the real estate yield with other properties.
Pros and Cons of Finding Profitability of Real Estate Using Cost Approach
The cost approach is the simplest and easiest way of determining the profitability of real estate. Anyone can use it without seeking outside help. However, the cost approach only calculates profitability based on the best use of the property, which isn’t always the case.
Additionally, real estate is often a victim to property zoning, which can reduce the property’s value.
2. Gross Rent Multiplier (GRM) Approach
The GRM approach to calculating the profitability of real estate does not consider the cost of repairs and rebuilding. Instead, it uses the annual rent received from the real estate and compares it with the cap rate percentage. The formula for the GRM approach is:
Property Profitability = Annual Gross Rents x Gross Rent Multiplier
In this approach, the GRM differs from the cap rate percentage such that the value of GRM isn’t in a percentage and is greater than 1. To calculate GRM, divide the real estate’s cost by the rent it generates in one year.
Pros and Cons of Finding Profitability of Real Estate Using GRM
GRM is simple to calculate and can give you an accurate estimate of the profitability of real estate. However, it may be challenging to find appropriate properties to compare to as not every property has the same expenses.
3. Income Approach
The income approach is similar to the GRM approach, but instead of the GRM, the formula uses the capitalization rate (Cap rate). The income approach is one of the most used methods of determining the profitability of real estate.
Property Profitability = Net Operating Income / Cap Rate
The Cap rate is like GRM but we express it as a percentage. In many cases, you would determine the Cap rate by comparing the property to other local properties that are similar.
Pros and Cons of Finding Profitability of Real Estate Using Income Approach
The income approach considers many recent real estate activities. We can also adjust the approach under unique circumstances. However, it does not count for collection loss or vacancy or consider the repair costs, resulting in errors in NOI calculation.
4. Sales Comparison Approach
The sales comparison approach (SCA) is one of the most reliable methods. Another name for it is the market approach. This approach compares the prices of similar recently sold or listed properties to determine the profitability of real estate.
For this approach, we use the property’s features, such as the number of rooms and square footage, to find similar local real estate that has been sold. The more recent the sale, the better the profitability calculation.
Pros and Cons of Finding Profitability of Real Estate Using SCA
The sales approach relies on recently received data with little chance of error, resulting in an inaccurate valuation. However, it does not account for a vacancy, collection loss, or additional repair expenses. Additionally, many properties have different features that may set them apart from yours.
5. The Capital Asset Pricing Model
The Capital Asset Pricing Model (CAPM) is one of the most intensive methods to determine the profitability of real estate. This is perhaps because, unlike other methods, CAPM analyses the risk factors involved when determining the profitability of real estate.
The method analyzes the return on investment (ROI), derived from comparing it to other assets with no risks. If the expected return on an investment that does not have any risk is more or equal to the expected profitability of real estate, then there is no point in investing in that property.
Pros and Cons of Finding Profitability of Real Estate Using Cost Approach
CAPM is easy to use and takes into account multiple risk factors to calculate the profitability of real estate. However, it does not consider all risk factors and is still under development.
Robert Defalco Realty
With agents with years of experience, we use different methods together to get the most accurate determination of the profitability of real estate, saving you a lot of time, effort, and money. Visit us at our offices or call us at 718-987-7900.
As of 2021, the commercial real estate market in the USA was estimated to be around $9.5 billion. The real estate market is forecasted to reach $14.6 billion by 2030. Accordingly, it is safe to say that now is the best time to invest in commercial real estate. However, you would need to know how to determine the profitability of real estate before making any investment.
According to Forbes, you could lose money in real estate only if you sell in unfavorable conditions. However, according to us, another way you could lose money in real estate is by investing under unfavorable conditions.
Knowing when to invest in commercial real estate and calculating the profitability of real estate is part of the job. You can get help from Robert DeFalco Realty, which has experts that can help you find the most profitable commercial real estate. Here are some ways they calculate the profitability of real estate.
