Nelson on Commercial Property Investment in PEI

Real estate property ownership has always been synonymous with wealth and power. Even the most modest home represents safety, security and independence for those who live there. Once those basic needs have been met, however, one can also look at real estate ownership as a very safe, secure and rewarding investment vehicle. That's not to say that real estate investments are risk free, but the risks can be planned for and minimized.

The key to making any sound investment is to look for value. This is as true for real estate as it is for stocks and bonds or any other type of investment product. But how does one define value? Are we talking about market value, assessed value, book value, insurable value, potential value or sentimental value? All of these “values” have slightly different meanings, but some of them are more important than others when one considers the “value” of real estate.

Investment value is defined as the value of real property based upon criteria established by the individual investor. It relates specifically to the amount of income that an investment property generates versus the cost to acquire that property, as well as the degree of risk of the income stream being interrupted. Investors looking to purchase investment properties first look at the Capitalization Rate or “cap rate”. Cap rate is defined simply as the amount of annual income derived from a property divided by the cost to acquire the property and then expressed as a percentage.

As a straightforward example, let's imagine a multi-tenant building with a mix of retail and commercial businesses and maybe some apartments on the second floor. Let's say that the property generates an income from rentals of $150,000.00 per year. Now let's assume that the operating and maintenance costs to run the building are $100,000.00 per year. The net income from this property is $50,000.00 annually once expenses are subtracted from revenues. If we were to purchase this property for $500,000.00, then our cap rate would be 10% ($50,000 /$500,000 x 100).

The cap rate is probably the most important variable for an investor to consider when looking at the purchase of an income generating investment property. The higher the cap rate, then the higher the income generated versus the cost to purchase. If the property above generated an annual income of $60,000.00, then the cap rate would be 12% ($60,000/$500,000 x 100). This would obviously be of more interest to a potential purchaser.

In trying to determine “investment value”, however, cap rate is not the only variable. Perhaps more crucial to making an investment decision, is determining the reliability of the property's income stream. If the main commercial tenant in the property example above is in the process of moving to a new building of their own within the next year, then the current income stream is not necessarily an accurate measure of investment value. Or if the proposed replacement tenant is a nightclub business, then maybe some of the remaining tenants are not going to stay. All of these factors must be looked at.

When it comes time to make your real estate investment decision, you need advice from an experienced and knowledgeable real estate professional. If you want to invest in, or divest of real estate in PEI, I can help you make an informed decision. With 25 years experience in commercial construction and real estate development, I know the “value” of investment real estate.