Thesis Driven’s next Fundamentals of Commercial Real Estate course is happening August 7-8 in NYC. Learn more and sign up here.
When hiring in proptech—or any other sector that serves the commercial real estate industry, like real estate law—employees need a fundamental understanding of how the real estate industry works.
So here’s a simple question to test a candidate’s real estate IQ:
Paul bought a building for $1 million. It generates $100k in rental revenue per year. It costs $50k per year to operate it.
Is Paul’s building performing well?
How someone answers this question can tell you everything you need to know about their fundamental understanding of the industry—and how well they’ll be able to sell into it.
But most proptech executives, let alone new hires, can’t provide a “C+” answer or better.
So what’s the right response? Here’s how a graduate of Thesis Driven’s Fundamentals of Commercial Real Estate course responded:
There are lots of factors to consider…
What are market cap rates? And is this a core or value add investment? A 5% cap / unlevered yield might be reasonable or aggressive depending on the market conditions. For a core property in a prime location, a 5% cap could be attractive. However, for a secondary market or a value-add property, this might be considered low.
The operating expense ratio of 50% is pretty high. Typically, a well-performing property might have an OER between 30-40%. So this indicates that operating expenses are consuming a significant portion of the revenue, potentially impacting profitability. This might be a good thing though because it suggests there may be cost savings opportunities for Paul via better management without having to increase rents or lease up more space.
What are market rents and vacancy? If these rents are higher than market and Paul's building has low vacancy, it suggests a well-performing asset (but maybe not a great investment). Conversely, if the market rents are similar but the building has high vacancy, there might be issues with management or tenant retention.
Is the $100K in revenue net of leasing commissions and tenant improvements? Net effective rents will provide a clearer picture of the property's long-term income potential as high leasing costs can significantly impact cash flow.
Did Paul use leverage? If so, what is the interest rate and term? If Paul financed the acquisition with a low-interest rate loan, his cash-on-cash return might be attractive despite a higher cap rate. Rising interest rates could impact future refinancing opportunities and property valuation.
Helping proptech executives and their employees—alongside other CRE providers, like real estate lawyers–better sell into commercial real estate is the big opportunity we’re addressing with Thesis Driven’s courses.
Our next course is in person on August 7-8th at 3 World Trade Center in New York City. Learn more and sign up here.
—Paul Stanton