hero image of blog post - Commercial real estate problems
Stanislav Naborshchikov
Stanislav Naborshchikov

Solutions Specialist

Commercial real estate problems

Commercial real estate - buildings, structures, or land plots used for commercial activities with subsequent extraction of permanent profit or capital gains, rental income, and investment income. A special feature of commercial real estate is a pronounced focus on income generation. The commercial real estate market began to form in connection with the privatization of enterprises, it is much smaller than the housing market, and the number of operations carried out is small, but due to the high cost of objects, it is attractive for structures operating in this market. The commercial real estate market is dominated by lease transactions, not purchase and sale or barter, as in the housing market. The market has great prospects and reserves for its development, especially in large cities, but it is developing slowly. By acquiring the rights to lease non-residential premises from the municipal fund, tenants are obliged to carry out maintenance at their own expense, improve the adjacent territory, etc. The rental rate depends on the type and location of the premises, the presence of a separate entrance, security, parking spaces, the number of telephone lines, proximity to the main city highways, and convenience of access. Within commercial real estate, despite the general function, there is still a certain classification associated primarily with the nature and type of premises, which are differentiated by a functional purpose: office, retail, warehouse, and production. Three main sectors have formed in the office market.

The first sector is prestigious offices that meet international standards for administrative premises. The rental rate in such premises is very high. For this reason, some of the entrepreneurs often rent first-class offices abroad at more affordable prices.

The second sector is formed by offices located in well-finished and equipped premises, and sometimes in resettled and qualitatively renovated apartments of large size. Rental rates here are acceptable for successfully operating firms, there is an active demand in this sector, which is constantly growing.

The third sector consists of premises in buildings of municipal and departmental non-residential funds, state enterprises (mainly scientific institutions), and cooperative and private enterprises. These are premises without finishing and repair and related services. Rental rates are low here.

The office space market has a good prospect for its development since the freedom of doing business leads to the creation of new business structures that need warehouse spaces for their functioning.

The market of retail premises. The main factor in the successful activity of trade enterprises is a favorable location, it determines the volume of turnover.

The greatest demand is for retail premises located near the main transport hubs, stations of various types of communication. The predominant form of transactions in the market of retail premises in the city center is the purchase and sale of retail premises, outside the center - rental of premises. The rental rates in the center and on the outskirts differ several times. Many buyers first rent a trading company to check whether or not the trade will go in this place, and then buy it. The practice is being developed when a land plot is leased on which trade is carried out from cars or from containers.

A dynamically developing segment of the real estate market is the warehouse market. It is characterized by stability, stability of supply and demand, prices. The market offers specialized warehouses equipped with loading and unloading equipment, heated, with reliable security, hangars, basements and semi-basements in administrative buildings, etc. Customs warehouses stand out in particular.

Currently, the following basic forms of provision of storage facilities are used: rent, responsible storage of cargo, responsible storage with insurance.

Rental rates in the warehouse market are differentiated depending on the degree of automation of the warehouse and the availability of special equipment, the location of the warehouse, distance from transport hubs. The supply in the warehouse market tends to grow. The cost of warehousing is significantly lower than the cost of housing, office space. An increase in the demand for storage facilities as the number of economic entities increases, there will be a guaranteed demand for storage facilities.

Let's take a closer look at the features of the industrial real estate market. For newly formed production structures, for the conversion of existing ones, production areas are needed. Most of the production areas are offered for long-term lease. The requirements for production facilities depend on the specifics and technology of production, fire and environmental safety requirements. Due to the ongoing economic crisis, the sale of enterprises as property complexes has not become widespread. Due to the imperfection of the methodological base and social concerns, the bankruptcy procedure has not yet been extended.

The business community is most interested in industrial real estate located in the regions, due to the significant cheapness. The prospect of this market depends on the prospects for the development of the national economy.

Difficulties in assessing commercial real estate are associated with a number of problems arising from the incorrectness or inconsistency of laws and regulations in this area. Let's look at these issues in a little more detail.

One of the problems is the choice of capitalization and discounting rates. There are several recommendations for choosing a bet:

- The cost of the loan (cost of capital) - for enterprises that do not have independent behavior (there is no securities market);

- The average marginal cost of own finances - for companies whose shares are listed on the market;

- Based on the average production profitability of the enterprise or its own industry.

- The profitability of an alternative investment (for example, a deposit account in a bank).

- Minimum risk-free return, from the investor's point of view.

- The real short-term interest rate, defined as the difference between the yield of treasury bills and the consumer price index.

In order to make an assessment to different specialists, it is necessary to adopt the value of the compound interest rate legislatively and reflect it in the methodology, as it was at the time, according to the standard coefficient of efficiency of capital investments (investments - as it is now customary to say). Initially, the efficiency rate was different for each industry, then one norm was adopted for all industries. It should be emphasized that the regulatory efficiency coefficient performed the same role as the capitalization rate (efficiency rate, comparison rate, investment placement rate).

Another problem is related to the use of point valuation of property. The situation is such that ten experts working independently of each other will give ten different estimates of the value of the same property. This is due to the calculation procedure and the choice of standard coefficients. The situation resembles the manufacture of a part. Different parts will be made on the same machine by the same worker according to the same drawing. There are a lot of reasons for this, most of which, in principle, cannot be excluded. Therefore, a system of tolerances for the dimensions of parts has been adopted in production. If the dimensions of the manufactured part are within the tolerance, then it is considered suitable. The deviations and spread of the initial data used for calculation in all approaches and methods, as a percentage of the average, are more significant than the tolerances for the dimensions of the parts.

Another important problem is the choice of weighting factors when coordinating the calculations of the value of property performed by three approaches. Each author (expert, appraiser) accepts weighting coefficients (coefficients of significance of the calculation method) at his discretion, and the difference between the estimates is significant. One of the ways out of this situation is to adopt a weighting coefficient evenly distributed in a certain range for each evaluation method (approach).

An acute problem arises in the comparative (market) valuation of property, when it is necessary to introduce correction factors to bring the assessed object and market analogues to a comparable form. There is also considerable arbitrariness here. This is especially true of the correction coefficients when comparing the locations of the assessed property objects and a number of others.

One of the most difficult problems is the reliability of information. This applies both to market information about the requested and sold price of the estimated value of the property, and information on standards when calculating the value by the regulatory method in the cost approach. Previously, design and technological institutes of all branches of the national economy had this information. Such information is either lost or outdated.

Based on the actual ways of using such premises as the office of LLC "Own Apartment", the cost can vary significantly. If everything is simple in the residential real estate market in this regard, it is impossible to use an apartment except for living or renting for living, then the situation with offices is much more difficult. In the evaluation process, the most effective way of using the premises is selected, and actually evaluates the business. The result of such work may come as a surprise to the owner of the valuation, if it suddenly turns out that the premises are being used completely inefficiently, and can potentially bring in much more income than it brings now.

Matt Sadowski / CEO of Mobile Reality
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