Formula for Buying Commercial Property With The Best ROI

Naresh Arora
4 min readApr 5, 2021
Formula for Buying Commercial Property With The Best ROI — by Pre-lease Property
Formula for Buying Commercial Property With The Best ROI — by Pre-lease Property

Buying commercial property is not as complicated as it might seem. One will gain even better returns than most debt instruments if you obey the principles of long-term investing. When investing, keep the following points in mind.

Know your market — Try finding an opportunity in the nearby area:
Suggestively, purchase the first few properties in an environment you are familiar with, at least to start the ball rolling. Spend a few weekends in your target market for a couple of months if you are unfamiliar with the city. Choose and drive around the 2–3 areas that you are interested in and speak to neighbors, local shop owners, property managers, and other locals to get a sense of the neighborhood and the potential clientele.

Property Classification:
Classification of properties might differ from person to person and strategy to strategy but one of the ways to classify it is as follows where the properties can be divided into three categories-

Class A:
These are properties of superior quality, usually located on the outskirts of the city, in the developing areas. Owing to their unique location and developing nature, there is a lack of public transport around these properties. Initially, the prices are low and the hike in price majorly depends on the growth of the city and surroundings.

Class B:
This category of properties are similar to the ones of Class A. Apart from the superior quality and its prime location in developing areas of the city, the only addition is that the city area is now stretched and reaching these areas becomes much more convenient. Due to this development, these areas are very easily connected with public transport which increases its reach. The prices of these properties are economical and the price hike would only act as a catalyst in the future growth. Owing to the factors mentioned above, this class of properties are considered to be the best buy among the three classes discussed here.

Class C:
Properties falling under this category are usually located in the heart of the city. This factor makes it easily accessible by public transport and is naturally overpopulated which gives these properties a red signal. Over and above which, the initial price of these properties is pretty high but the chances of a price hike in the future hardly exist.

Formula for finding the best ROI

The Golden Percentage Rule of Property Investment:

Buy below market 10–20%:
Consider this not only as a means of increasing your net worth, but also as a means of maintaining your financial stability. If you ever have to sell for a cause, that 10–20 percent will allow you to lower your offer price and sell it faster. On the plus side, if you don’t have to sell in a hurry, you have just gotten a fast return on your investment.

Property should generate a minimum of 15% ROI, cash on cash:
That means the rent must be at least 15% higher than the loan (if mortgaged) and expenses. A Rs 15,00,000 down payment, for example, will have to generate at least Rs 2,25,000 in annual cash flow. This is actually very low; most transactions should be well above the 20% level.

Buy Class B commercial property with a higher chance of price hike & average rental income.

The rent should be at least 1% of the purchase price:
For instance, a Rs 7 crore property should rent for at least Rs 7,00,000.

Do your due diligence regarding repairs before buying:
Move on to the next property if the repairs plus the down payment reach a 15% return on investment. This is also similar to the 70% rule.

Maintain six months / half year of cash reserves per property to pay the debt service:
This should cover any unanticipated maintenance or vacancies.

The 50% Rule:
The 50 percent rule is a guideline for conducting a first-pass analysis on a rental property. According to the law, the overall expenses associated with running a rental property investment would be about 50% of the gross rentals on average.

The 70% Rule:
The 70 percent rule states that an investor should pay 70% of a property’s ARV (After Repair Value) minus any necessary repairs.

The 5% Rule:
The 5% rule broadly suggests that one should spend 5% of their income on repairs and maintenance.

The 3 Day Rule:
According to the three-day provision, the borrower must send the Closing Disclosure (a document that contains the final details of the loan) to the customer at least three business days before the transaction’s completion date. This demonstrates that the buyer is ready, willing, and able to close on the home, enforcing the contract and demonstrating that the sale is ready to go. This shows the buyer’s willingness to follow through with the terms of the purchasing agreement.

For the longest time, the next few years will almost definitely be remembered as the best time to buy income-producing rentals. In many markets, you can buy land for a fraction of the cost of construction. The interest rates are at an all-time low. Generation Y is three times the size of Generation X, and it is predicted that they will continue to rent for the near future, despite the fact that property prices have plummeted and rent costs have skyrocketed.

--

--

Naresh Arora

A realtor on a mission to help others in the fields with my good and bad life experience. Providing the best piece of advice to make life more enjoyable.