Determining the highest and best use of a commercial real estate property is one of the toughest challenges that many investors face. Not only is it crucial to determine the effective use of the property in isolation, but it’s also crucial to assess the potential value associated with alternative uses.
Here are three steps to determine the most effective use of commercial real estate property.
Step#1: Legal Permissibility
The first step is to determine whether the use is permissible by law.
No matter how good and profitable an idea, if it’s not legally allowed, then there’s no point in investing more energy and resources into it.
From zoning restrictions to environmental regulations, there are many aspects that must be considered before going ahead with a plan to prevent the wastage of resources.
Checking the legal permissibility should be the utmost priority when determining the most effective use of your commercial real estate property.
Step#2: Physical Possibility
Once you get a green light from the legal side, it’s critical that you evaluate whether the physical use of the idea is actually possible.
This means that the accessibility, shape, size, and other elements of the property are practical and safe.
For instance, it’s not physically possible to build with a 400,000 square foot base on a 300,000 square foot lot.
Even if it’s hardly possible, a poorly designed property will require additional cost to build and also make it extremely difficult to utilize the complete portions of the land.
Step#3: Financial Feasibility
Finally, once you make sure that the project is legal and physically possible to develop, it’s time to check the financial feasibility of the plan.
First, you need to carry out market analysis and develop proforma net operating income and cash flow estimates to calculate net present value.
If the value is positive, the project is financially feasible. But the figures used in the calculations –such as interest rates, vacancy rates, and cap rates—are highly volatile.
Therefore, it’s important to use a range of ratios such as internal rate of return, yield-to-debt ratio, among other metrics to reliably assess the financial prospects of the investment.
Bonus Step: Maximum Productivity
This step is a no-brainer, but it’s very important to shed some light on it to ensure the most effective use of your commercial real estate property.
It involves taking all the proposed ideas of property used in the most effective way and assigning a rank on them based on their net present value or rate of return.
As a result, you’ll be able to determine the maximum productivity and what use of the property would provide the maximum net income.
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