Cash flow and the riskiness of our cash flow are the two property-specific levers that drive our commercial property’s value. More cash flow means more value. Less risk means more value.

In this post, we’ll focus on how we can increase our property’s value through increasing cash flow and reducing property-specific risk.

SUMMARY

Commercial real estate value is driven by two levers: cash flow and the riskiness of that cash flow. This post breaks down a five-step process for increasing our property’s value:

1. Understand market supply and demand for similar space.
2. Determine our market-rate potential for rent and terms.
3. Quantify the cash flow and valuation gap between our current and market-rate performance.
4. Take strategic action to raise rent, secure stronger tenants, and reduce risk.
5. Decide how to capture value — through higher cash flow, refinancing, or sale.

This is a process for turning underperforming commercial properties into wealth-building assets through smarter leasing, market awareness, and tenant selection.

⏱ Estimated reading time: 8–9 minutes

Commercial real estate is valued differently than single-family homes. In commercial, what matters is functionality and return on investment. Whereas for single-family homes, it’s about how much a family will pay to live there, which is based on nearby comparable homes. How we invest a dollar in commercial can be quite different from how we invest a dollar in a home.

Businesses are profit-motivated and buy or lease real estate for their operations.

As a commercial owner, remember that our tenant businesses are making decisions based on best usability, highest quality, and lowest cost – even if it’s our own business leasing the property.

As a commercial property owner/investor, we’re in the business of providing leasing space to other businesses. Supply and demand still determine our property’s value because supply and demand determine our property’s cash flow and riskiness. Super high demand? Stronger leasing rates, fewer concessions, and favorable Landlord terms increase our cash flow and decrease our risk; low and slow demand? The opposite.

How do we increase our cash flow and decrease our risk as property owners?

1. Understand our market’s supply and demand for leasable space similar to ours.
2. Understand the market-rate potential for our property.
3. Understand the market-rate cash flow and valuation difference for our property.
4. Take action on increasing our property’s cash flow and reducing risk.
5. Decide what to do once the increased value has been captured.

1. Understand our market’s supply and demand for leasable space similar to ours.

How many other buildings are leasable today similar to ours: Location (5-10mi radius), size (square feet), age, condition, features, zoning, etc.

How many buildings are currently being developed and how many permits have been issued to develop new commercial space similar to ours?

How many businesses are actively seeking space like ours today? How many businesses will likely be looking for space like ours in the future, given market conditions and trends? What’s driving growth in our market, and will that bring more businesses to market that will need space like ours?

These can be hard questions to answer. It takes research, conversations, and thought. Start by looking online on loopnet.com, crexi.com, and local commercial brokerage websites in your market. Filter by size and type of real estate. Office is different from industrial, etc. Call different brokers and ask their opinion of the market, what’s driving growth, what new businesses are coming to town, whether they’re working with businesses who need space, and what their thoughts are on current supply vs. demand. How long are spaces on-market before they’re getting leased? How much interest have they received at their current offered lease rate and terms?

Once we have an understanding of what’s going on in the market and where leasing rates are, then we move on to #2.

2. Understand the market-rate potential for our property.

If we have a flex warehouse that’s 6,000 SF, and our market research and conversations lead us to believe that the going rate is $12 per square foot triple-net ($12 NNN), then that’s $72,000 of rent per year (6,000 SF x $12 = $72K). How does that compare to what our property is generating today?

Are most of the on-market leasable spaces triple-net, which means the tenant pays for property taxes, property insurance, repairs and maintenance, and most (if not all) other operating expenses? Or are most on-market leasable spaces full service gross, which means the tenant pays their one flat rental payment per month, and the landlord pays freight on everything else? Or is it somewhere in between?

Our goal is to understand what’s taking place in the market and where deals are getting done. This is achieved through research and having meaningful conversations with brokers. Once we understand where deals are getting done, we then apply those prices and terms to our subject property.

Understand our tenant’s next best option: What is the most likely competing property they’re looking at alongside our space? Suppose they don’t sign or renew with us, where would they go? What are the pricing and terms for competing property? How does our property’s usability and economics compare?

3. Understand the market-rate cash flow and valuation difference for our property.

Assuming we have a 6,000 SF flex warehouse space, let’s say we’re currently receiving $50,000 in rent per year. Our tenant does not pay for property taxes or property insurance, and let’s say those together are ~$10K per year. That means we’re earning $40K per year.

After doing our research, we believe $12 NNN is market-rate. That’s $72,000 per year. The difference between market-rate and our current net operating income is $32,000 ($72K - $40K = $32K). That’s $2,666 per month.

That’s a meaningful cash flow difference. $2,666 pays some bills. But what about the valuation difference?

While we’re talking to brokers, we also want to ask where cap rates have been trading in the market for certain property types. [I’ll explain cap rates in detail in another post. For now, a cap rate is your Net Operating Income divided by the Purchase Price.] If we know that cap rates are 7-8% for our property type in our market, then we can divide our cash flow difference by the cap rate to understand how much we could increase our property’s value.

Dividing $32,000 by 7% and 8% creates a potential value increase range of $400K – $457K. ($32K / 8% = $400K and $32K / 7% = $457K)

This is real money that becomes accessible when we have a quality tenant and market-rate lease in-place.

4. Take action on increasing our property's cash flow and reducing risk.

Cash flow is only as valuable as the probability of it occurring. Fantastic lease terms with a tenant business that has little-to-no cash in the bank, is less than a year old, has only one or two customers, and could go out of business in several months is not a great deal. The riskiness of that cash flow is significantly higher than a tenant business with meaningful cash in the bank, a diversified customer base, longer-term customer contracts, has been in business over 10 years, and has a reputable history with its banking partner.

Know who we’re doing business with and how likely they are to be able to pay rent long-term.

Analyze prospective tenants in detail. Know their financial situation. Know their history. Know their business.

• What do they do?
• Who do they sell to?
• How do they get paid, how often, and when do they receive the cash?
• What are their operating margins?
• How much cash comes in each month, how much cash is required to operate their business, and how much is left over to:
  1. pay our rent and required expense reimbursements,
  2. pay the business owner (broke owners will shut down their business and not pay rent), and
  3. reinvest into growing the business (if it's not growing, it's dying)?

If our property currently has a month-to-month tenant:

Based on market research, how likely is it that we can find another tenant at market-rate terms quickly? If odds are good, we have negotiating leverage. We need to approach our current tenant and propose a competitive lease agreement, rate, and terms. Let them know that we’re coming to them first in good faith and fully intend to give them preference. But we still underwrite and research their business, financial health, and operations just as thoroughly as we would any other prospective tenant. At the same time, we’ll go to the marketplace and offer our space for lease. This further strengthens our negotiating position because the tenant knows others will be interested in our space, and we’ll have options to choose from. Competition and demand lead to better options and outcomes for us.

If our property has a long-term lease in-place:

There may still be options to explore with our tenant, depending on the situation. For example, will our tenant be agreeable to new lease terms in exchange for additional investment in the property or something else valuable to them? Would they be agreeable to a higher lease rate in exchange for an extended lease term, providing them longer-term security in their space? Ask ourselves: What can we offer our tenant in exchange for them signing new lease terms?

If our property is vacant:

First, why is our property vacant? Because we just moved our own business out, because our space is overpriced for what it offers, or because its condition and usability is bad and it requires investment to make it market-ready? We need to understand whether our space requires improvements to demand market-rate lease terms with a quality tenant business.

• If it’s not market-ready, we can still market our property for lease by offering tenant improvements. This means that if we agree to lease a space to a tenant, we’re willing to pay to improve the property and make it suitable for them. This saves us from investing in improvements up-front that may not be valued by the tenant, while also making it more ‘customized’ for the tenant. If heavily customizing for a tenant, our lease needs to be long-term and we must make sure their financials are strong and dependable.
• If it is market-ready, we go to market quickly and offer market-rate terms. We’re optimizing for two variables: Best terms and best tenant. Someone can promise the world and go out of business six months later. We need to solve for best terms and cash flow, as well as the strongest tenant who’s likely to pay long-term and take great care of our property.

5. Decide what to do once the increased value has been captured.

We’ve now signed a market-rate lease with a strong, creditworthy tenant. Our cash flows have immediately increased and so has our property’s value. We now have three options.

1. We cash flow the property as-is and enjoy stronger cash flows. This increases our monthly earnings and we can build long-term wealth through reinvesting these cash flows elsewhere.
2. We can refinance the property. This allows us to pull cash out, tax-free, immediately for reinvestment elsewhere.
3. We can sell the property. We take the remaining proceeds after taxes and fees and reinvestment elsewhere. Note, this can sometimes be the least tax-efficient option. Always know your options and each option's tax situation.

These five steps are how we can build serious wealth in commercial real estate. Do it once, then again, and again…

Subscribe to dojorealestate.com and I’ll share more valuable content, training, and tools to build your wealth through commercial real estate.

Need help improving, selling, or buying commercial real estate? Contact me here and we’ll discuss your situation, your options, and the pros, cons, and risks for each option.

- Jamie

​

Jamie Carlstedt Working with commercial property owners and investors to improve, sell, and invest in commercial real estate. ​Subscribe here for free content, training, and tools. ​Contact me here for commercial real estate services. Commercial real estate advisory, brokerage, and investment.

​