Every time I sit down with a buyer who’s excited about a commercial property, the first thing I do is pump the brakes — not to dampen enthusiasm, but to make sure the first analysis is the right one. The most expensive mistakes in commercial real estate happen when buyers fall in love with a property before they’ve stress-tested the fundamentals.
So when purchasing commercial property, what should the first analysis be? Here’s my answer, built from years of transactions across multiple asset classes and markets.
Start With the Income and Expense Picture
Before you evaluate anything else — location, aesthetics, tenant mix — you need to understand whether the property generates enough income to justify the price and carry the debt. That means building a proforma that includes:
- Gross potential rent: What the property would generate at full occupancy at market rents
- Vacancy and credit loss allowance: A realistic assumption, not an optimistic one
- Effective gross income: Gross potential rent minus vacancy and credit loss
- Operating expenses: Property taxes, insurance, maintenance, management fees, and reserves
- Net operating income (NOI): Effective gross income minus operating expenses
NOI is the engine of commercial real estate value. Everything else is context.
Apply the Market Cap Rate
Once you have a credible NOI, divide it by the prevailing cap rate for comparable assets in your submarket. This gives you an implied market value:
Value = NOI ÷ Cap Rate
If the seller’s asking price is significantly above this implied value, you’re either overpaying or the seller’s income assumptions are too aggressive. Either way, you need to know before you go further.
Stress-Test the Assumptions
I always run three scenarios with my clients:
- Base case: Stable occupancy, market rent growth, and modest capex
- Downside case: Vacancy event, rent rollback, or unexpected capital expenditure
- Upside case: Lease-up of vacant space, rent growth above market, or value-add execution
If the downside case still produces acceptable returns, the deal has resilience. If the deal only works in the upside case, it’s not a deal — it’s a bet.
Evaluate the Market Fundamentals
After the numbers, look at the market:
- Submarket vacancy rates: Is demand outpacing supply?
- Rent trends: Are market rents growing, flat, or declining?
- New supply pipeline: Is new development about to compress rents or occupancy?
- Demand drivers: What industries and employers are driving leasing activity?
A great deal in a deteriorating market is still a difficult hold. Conversely, a modestly priced asset in a strong market can outperform expectations significantly.
Don’t Skip the Lease Audit
The rent roll is the heartbeat of any income-producing property. Before you go deep on due diligence, understand:
- Who are the tenants and what are their lease terms?
- When do leases expire and what are the renewal options?
- Are there rent escalations, and do they keep pace with inflation?
- What is the tenant credit quality?
A property with strong cash flow today but a wall of lease expirations in 18 months is a different investment than it appears on the surface.
My Bottom Line
When purchasing commercial property, the first analysis should always be a rigorous review of income, expenses, market value, and lease structure — before you tour the building, before you meet the tenants, and definitely before you fall in love with the asset.
If you want a partner who will run that first analysis with discipline and give you a straight read on whether a deal makes sense, I’m Matt Bingaman. Contact me today and let’s start with the numbers.