February 2014  |  St. John's Board of Trade Business News, Volume 28, Number 1  | Glen Power AACI

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Commercial real estate values have grown steadily in the St. John’s area since the late 1990’s. Businesses fortunate enough to have acquired real estate assets prior to or at the front end of this growth period may have added significant value to their balance sheets. Value growth has been strongest during the previous five to ten years and values continue to rise in most sectors. While your property value has likely increased, it is possible that you may not be in a position to achieve the maximum value potential of your asset. Value maximization requires sound asset management strategies, and an understanding of how real estate value is created and maintained within the commercial market sectors. 

 

Within the St. John’s market, the majority of commercial-light industrial real estate is owner-occupied, or partially owner occupied, and for the most part owner-managed. For those of you who have decided to self-manage your real estate assets, it is important that your management approach recognize a number of fundamental concepts of value, otherwise there is a danger that the current or future value of your asset is less than you think, and less than its maximum potential in the market place.  

 

For starters, it is important to understand which parties comprise the potential market for your real estate asset. Your property is only worth what someone is willing to pay for it, and some market segments may pay more than others. Furthermore, the property may be worth more to your company. Its value-in-use as part of your business operations may be greater than what the market is willing to pay. If this is the case, there are strategies to ensure you achieve maximum investment return. 

 

In very general terms, the potential market for your property is either comprised of investors, owner-occupiers, or both. Understanding what factors influence purchase decisions associated with each group or sub-group is key to understanding how to maximize the value of your property. Under certain market conditions, owner-occupiers are often willing to pay more than investors, and national institutional investors may pay more than local investors, depending upon the location, tenant mix, income stream characteristics, etc. 

 

Some real estate assets may be ripe for redevelopment, particularly those that have been held by companies on a long-term basis, and may now be situated within neighbourhoods that have completely transformed with other uses. In such cases it may be that the best business decision is to move the business to a more appropriate commercial location, and sell the existing asset for redevelopment purposes. 

 

A common situation within our market place is partial owner-occupancy, with multiple tenants occupying the balance of the property. Such an asset would likely attract investor interest. In my experience however, the investment value is often less than the property’s potential due to a number of common mistakes made by owners that raise the level of risk in the eyes of savvy investors. 

 

Investors formulate purchase price through evaluation of the income and expense characteristics of the property, and the level of risk associated with maintenance and growth of cash flow. The quality of the tenancy is evaluated, as well as the potential for revenue growth and the overall liquidity and value of the asset at the end of the intended investment period. All of these items, among others, are factored into the Overall Capitalization Rate that an investor is willing to accept. 

 

While many institutional investors use sophisticated income modeling for evaluation of real estate assets, all investors, from small local investors to the largest institutional investors, use Overall Capitalization Rate applied to Net Operating Income to formulate value and purchase price.  For those of you not familiar with the commercial real estate industry’s most basic formula, Market Value = Net Operating Income / Overall Capitalization Rate. 

 

In self-management of your asset therefore, you must strive to maximize the potential Net Operating Income while lowering the overall investment risk. The lower the risk, the lower the Overall Capitalization Rate that the market would accept, and the higher the potential value of your property.  Achieving this requires detailed knowledge and experience of the commercial real estate market, or otherwise professional assistance for implementation of appropriate policies and strategies. 

 

Commercial real estate is an extremely complex field, and the value of your property may be impacted by myriad factors that you may not be aware of, including national leasing and investment trends, lending policy, design trends, advancing technology, etc. While hiring a professional property manager is one way of minimizing risk and maximizing value, another method is to engage a professional appraiser familiar with your property type. 

 

Many commercial appraisers today strive to provide an added value service, whereby detailed valuation reports identify value maximization strategies, as well as shortcomings in your management approach.  A small investment in professional advice may be the wisest investment you’ve ever made in management of your commercial property.  

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