By Gary Tasman
As the population continues to boom in Southwest Florida, real estate development is also keeping pace. Naturally, the rapid addition of residential areas is spurring the proliferation of commercial real estate development. All those new residents require office space, industrial and manufacturing facilities, shopping, and restaurants.
Who is investing in these properties, and what is considered a quality real estate investment? Investors come in different shapes and sizes, and have varying means for accomplishing their investment goals. For income investors, there is of course a common goal: Net Operating Income, which is the gross rental income minus all operating expenses.
In Southwest Florida, perhaps 90 percent of the commercial real estate market is comprised of non-institutional grade income properties. As the area continues to grow and attract more national names, this percentage may eventually change. However, for now this is still a smaller investor's town.
Non-institutional grade properties in this market are typically bought at a price based on a 10-11 percent capitalization rate. What's a capitalization rate? Capitalization is the process of converting the property's income stream into property value. It answers the question: How much is the market willing to pay for X dollars of net operating income per year? It's a simple equation for figuring out the value of the property based on expected income.
Non-institutional property values can also be impacted by the existing income generated by leases, the terms of the leases, location and the condition of the property. Generally occupied by local businesses, the success of these properties often relies on sound and professional property management. Daily maintenance, landscaping, lighting, capital improvements, signage and lease restrictions must be attended to in order to create an inviting environment.
Beyond a good cap rate, non-institutional investors should also look for areas of future income potential, such as a vacancy that can be filled or additional land that can be developed. If the current income stream provides below market rent, an investor can raise the rent to the market standard.
Investors in institutional grade properties and tenants who rent from them have stringent criteria. They require Class A construction and at least one anchor tenant to serve as the primary "traffic generator." These tenants are most often regional or national companies, such as Publix, that require a prime location and well-maintained property.
There are many benefits of investing in institutional-grade properties. They provide steady, predictable income, and enjoy longer leases. If a tenant business is publicly owned, it is less likely to default on its rent, thus the income stream generated is dependable. And whether the business stays in that location or not, the tenant will continue to pay until its lease expires, fulfilling its obligation. Overall, these tenants are less risky.
For example, the closed Kash-N-Karry on College Parkway and Winkler Road in Fort Myers is still paying rent, even though its doors have been closed for years. While some property owners may be tempted to sit back and collect rent on a vacancy, there are many disadvantages to doing so. With a gaping hole in the plaza, shoppers might prefer to go elsewhere, and other tenants may decide to leave and rent from a more stable center.
The market capitalization rate for institutional-grade properties in this market is 8-10 percent. Using the equation Value of Real Estate equals Net Operating Income divided by Capitalization Rate, the lower the cap rate, the higher the property's value. The cap rate can also be thought of as the perceived risk of the tenant, whether or not it will stay and pay rent. Thus, institutional-grade properties typically sell for lower cap rates due to the lower risk.
Growth and Income
As the Southwest Florida market is primarily made up of non-institutional grade properties, investors should consider real estate a readily available option. With a growing number of people in Southwest Florida, the market is thriving, and there are many promising opportunities. Whether an investor purchases a build-to-suit or an existing center, there are businesses looking to lease and consumers looking to spend.
Gary Tasman specializes in investment property sales and commercial property leasing with Grubb & Ellis|VIP-D'Alessandro, a full-service commercial real estate and property management company serving Southwest Florida.