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How to Get into Commercial Real Estate

Step-by-Step Career Guide on How to Get into Commercial Real Estate Investing (CRE)

Last Updated June 11, 2024

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How to Get into Commercial Real Estate

How to Get into Commercial Real Estate Investing

The commercial real estate (CRE) asset class is comprised of properties used for business purposes, as implied by the name. For instance, some of the more common commercial properties include office buildings, retail spaces, warehouses, and hotels.

Contrary to residential real estate, the commercial real estate sector focuses on generating rental income via long-term leasing arrangements and selling commercial properties at a profit.

  • Commercial Real Estate (CRE) Market Knowledge ➝ Understanding the current market trends and remaining up-to-date on the latest developments is critical to securing an investing role at a CRE firm. Therefore, remain informed of the latest developments and market sentiment because that sort of knowledge can help facilitate informed investment decisions.
  • CRE Analytical Skills ➝ Analyzing a potential investment and arriving at a sound thesis on the individual property is a comprehensive process because of the sheer number of moving pieces that can impact the return on investment. Performing diligence on the financial data of the underlying property and creating a pro forma forecast using assumptions supported by historical data is necessary. However, the state of the CRE market at present, sale prices of comparable properties, supply/demand trends, and economic conditions (e.g. interest rate environment) must each be closely considered.
  • Excel Proficiency (and Argus) ➝ For CRE professionals, familiarity with Excel improves workflow efficiency while mitigating the risk of errors. In addition, property management software like Argus and data analysis tools can further enhance one’s productivity on the job.
  • Technical Acumen ➝ The common real estate metrics used to estimate the implied return on property investments are necessary to master to perform well. But more importantly, the intuition behind each metric—i.e. the underlying core drivers—must be grasped, and the connections between each metric are crucial to tie the insights into a formal investment thesis.
  • Build a Network ➝ Effective communication is a skill applicable to essentially all career fields, including real estate. By networking and building close relationships with employees at CRE firms, the likelihood of becoming hired is greater since that shows a candidate can collaborate with other CRE professionals, employees, and clients. In short, networking can open doors to job opportunities, partnerships, and the gradual accumulation of industry knowledge over time.

How to Prepare for Commercial Real Estate Investing

First and foremost, understand that your resume is the source for most of the initial questions, and every detail included is subject to scrutiny during the interview.

In short, most of the behavioral questions are derived directly from your resume, so be ready to elaborate on each bullet point and respond to any follow-up questions.

Each item listed on your resume should be directly relevant to the position for which you’re interviewing, and you should be able to expand upon the bullet point with relative ease.

Therefore, come prepared to discuss your resume in depth and anticipate potential questions that may arise.

If commercial real estate is genuinely your chosen career path, and you spent sufficient time researching the firm’s background and investment strategy, answering behavioral questions that pertain to your interest in joining the firm should be straightforward and conversational.

While the following should go without saying, it is imperative to be truthful on your resume. If you feel the need to lie on your resume, you are likely not qualified for the position (and the potential downside is never worth the risk).

Begin your preparation early and conduct thorough research on the firm. In short, avoid procrastinating at all costs because the effort you put into learning about the firm will be evident in the interview.

Firms can easily discern candidates with genuine interest from the rest early on in the interview process, so make sure you come across as well-prepared and fully committed to joining the firm.

Here are some of the key topics to research on a given real estate firm ahead of an upcoming interview:

  • Investment Strategy ➝ What is the firm’s investment strategy?
  • Property Types  What types of properties does the firm invest in?
  • Financing Structure ➝  What is the financing structure of the firm’s investments (e.g. mix of equity or debt)?
  • Fund Investment Criteria ➝ What are the firm’s investment criteria (e.g., geographical focus, transaction size, risk/return profile)?
  • Past Transactions ➝ Explain a past transaction completed by the firm that you found interesting (and why).

One final tip on preparing for technical questions: remember that “practice makes perfect,” so participate in mock interviews to hone your skills, especially under timed pressure.

Career Tips: Commercial Real Estate Investing Knowledge

Following the commercial real estate market is an absolute must for those pursuing a career in the field.

Part of impressing an interviewer and securing a job offer is showing your passion for commercial real estate, which requires understanding the current market trends that impact investment decisions and recent commercial real estate transactions (or deals).

Why? Timing is one of the most important core drivers of returns in commercial real estate investments.

That said, it is crucial to come into the interview prepared to speak about, at the very least, one notable real estate deal in-depth.

Before the interview, prepare a one-pager with the transaction deal terms and the intuition behind the investment strategy to show that you are capable of thinking like a commercial real estate investor.

Why? That sort of skill set is precisely what real estate firms seek in a potential hire.

How to Follow the Commercial Real Estate Market (CRE)

Our top recommendations to follow the commercial real estate industry and market trends are as follows.

Top Commercial Real Estate Newsletters (2024)

Commercial Real Estate Newsletter

Top Commercial Real Estate Interview Questions

In the subsequent section, we’ve outlined some of the most frequently asked interview questions in the commercial real estate (CRE) interview process.

The list of compiled CRE interview questions covers the core basics needed to get into commercial real estate.

However, fill out the following form to access our comprehensive real estate interview guide.

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Q. What happens to the property values in the commercial real estate (CRE) market when interest rates rise?

When interest rates rise, the capitalization rates most often follow suit. Moreover, if cap rates increase, property values tend to decline.

However, there are some economic benefits that can help mitigate the decrease in property values.

Fundamentally, rising cap rates are frequently a sign of a strong real estate market and economy, signifying that the real estate outlook is likely positive.

Since rising interest rates mean higher financing costs, the pace of new supply (i.e. new properties flowing into the market) can slow down while demand remains the same, so rent tends to increase in such times.

Q. Why do higher interest rates cause real estate purchase prices to decline?

If interest rates increase, borrowing becomes more expensive, which directly impacts the returns of real estate investors.

In a higher interest rate environment, investors must offset the higher cost of financing with a reduction to purchase prices – since a lower purchase price increases returns (and enables them to achieve their targeted return).

Therefore, as interest rates climb upward, cap rates are also expected to rise, placing downward pressure on pricing.

Q. What is the net absorption rate?

The net absorption rate is a measure of supply and demand in the commercial real estate market, so the metric attempts to capture the net change in demand relative to supply in the market.

Calculating net absorption involves taking the sum of physically occupied space in square feet and subtracting the sum of square feet that became physically vacant over a specified period, most often a quarter or a year.

Net Absorption = Total Space Leased Vacated Space New Space

Q. What is the difference between positive and negative net absorption?

  • Positive Net Absorption ➝ More commercial real estate was leased relative to the amount made available on the market, which suggests there is a relative decline in the supply of commercial space available to the market.
  • Negative Net Absorption ➝ More commercial space has become vacant and placed on the market compared to the amount that was leased, indicating the relative demand for commercial real estate has declined in relation to the total supply.

Q. What is the difference between NOI and EBITDA?

The net operating income (NOI) metric measures the profitability of a property investment before any corporate-level expenses such as capital expenditures (Capex), financing costs (e.g. interest expense), and depreciation and amortization (D&A).

Net Operating Income = Rental and Ancillary Income Direct Property Expenses

NOI is frequently used among real estate firms because it captures the property-level profitability of the firm prior to the effects of corporate expenses.

In contrast, EBITDA – which stands for “Earnings Before Interest, Taxes, Depreciation, and Amortization” – is most commonly used to measure the operating profitability of traditional companies, meaning NOI can be considered a “levered” variation of the EBITDA metric.

Q. Which is used more in real estate investment banking: NPV or IRR?

Both the net present value (NPV) and internal rate of return (IRR) are important metrics for all real estate investors to consider.

However, the IRR is arguably used more frequently because the metric represents the discount rate at which the NPV of future cash flows is equal to zero.

In other words, the minimum required return on an investment is based on the implied IRR.

Further, the IRR is more easily used to compare the returns on real estate investments relative to other asset classes such as equities, fixed income, and other types of real estate investments.

Q. What are the different types of leases?

  • Full Service ➝ A lease structure in which the landlord is responsible for paying all of the operating expenses of the property, meaning the rental rate is all-inclusive as it accounts for expenses such as taxes, insurance, and utilities.
  • Triple Net ➝ A lease structure in which the tenant agrees to pay for all of the expenses of the property, including taxes, maintenance, and insurance, all in addition (and separately) to rent and utilities. Because these expenses aren’t left to the landlord to pay, the rent on a triple-net lease is typically lower than in other lease structures.
  • Modified Gross Lease ➝ A lease structure in which the tenant pays the base rent at the beginning of the lease and then takes on a proportion of other expenses, such as property taxes, insurance, and utilities.

Q. What are the three methods for valuing real estate assets?

The three methods to value real estate assets are the cap rate, comparables, and the replacement cost method.

  1. Cap Rate ➝ Property Value = Property NOI ÷ Market Cap Rate
  2. Comparables ➝ The valuation is based on the transactional data of comparable properties, specifically based on metrics such as the price per unit, price per square foot, or current market cap rate.
  3. Replacement Cost Method ➝ CRE investors analyze the cost of building the property that they are considering purchasing (and, in general, most would avoid purchasing an existing property for more than it could be built).

Q. Compare the cap rates and risk profiles for each of the main property types.

There are four commercial property types in particular, which are each described in the following list:

  • Hotels ➝ Higher cap rates due to cash flows being driven by extremely short-term stays.
  • Retail ➝ Higher risk due to increasing creditworthiness concerns due to the rise of e-commerce.
  • Office ➝ Closely correlated with the broader economy but with longer-term leases, making the risk profile a bit lower.
  • Industrial ➝ Lower risk profile due to continued trends in e-commerce and longer-term leases.

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Q. Walk me through a basic pro forma cash flow build for a real estate asset.

  1. Revenue ➝ The calculation starts with revenue, which will primarily be rental income but could include other sources of income. From this, vacancy and leasing incentives will be deducted.
  2. Net Operating Income (NOI) ➝ Next, operating expenses are subtracted from revenue to arrive at the NOI.
  3. Unlevered Free Cash Flow ➝ From NOI, capital expenditures related to the purchase and sale of properties are subtracted to arrive at the unlevered free cash flow metric.
  4. Levered Free Cash Flow ➝ Finally, financing costs like interest are subtracted from unlevered free cash flow to arrive at levered free cash flow.

Q. If you had two identical buildings in the same condition and right next to each other, what factors would you look at to determine which building is more valuable?

The primary focus here should be on the cash flows, especially the risk associated with them (and the creditworthiness of the tenants).

  • Average Rent and Occupancy Rates ➝ Specifically, the average rents and occupancy rates of the buildings must be closely examined, as this sort of analysis can reveal differences in management and leasing (and potential issues).
  • Credit Risk ➝ The riskiness of the cash flows is also critical. The creditworthiness of existing (and future) tenants and the specific terms of the leases are used to gauge the credit risk. In short, a property owner wants to be near certain that rent will be collected on time from the tenant.
  • NOI and Cap Rate ➝ The net operating income (NOI) and cap rate of each property must be calculated. In short, the property with a higher cash flow and less risk will be more valuable.

Q. Describe the four main real estate investment strategies.

The four main commercial real estate investment strategies are core, core plus, value-add, and opportunistic investments.

  1. Core ➝ Of the four strategies, the least risky strategy (and thus, resulting in the lowest potential returns). The strategy typically involves targeting newer properties in locations with higher occupancy rates and tenants of higher creditworthiness.
  2. Core-Plus ➝ The most common type of real estate investing strategy, which carries slightly more risk by involving minor leasing upside and small amounts of capital improvements.
  3. Value-Add Investments ➝ A riskier strategy in which the risk can come from less creditworthy tenants, meaningful capital improvements, or substantial lease-up (i.e. more “hands-on” changes).
  4. Opportunistic Investments ➝ The riskiest strategy that targets the highest returns. The strategy consists of investments in new property development (or redevelopment).

Q. What are the risks associated with investing in commercial real estate properties?

Investing in commercial real estate (CRE) properties involves several material risks that potential investors must consider to mitigate the risk of incurring capital losses.

Here are some of the main types of risks posed by CRE property investments:

  • Vacancy Risk ➝ One of the primary risks in CRE is the potential for vacancies (or rental units without tenants). Unlike residential properties, which often have a steady stream of tenants, commercial properties can take longer to find suitable occupants. In effect, there can often be extended periods wherein a rental property (or units) remain empty, and no rental income is generated.
  • Economic and Market Risks ➝ The CRE market dynamics (supply-demand) are closely tied to the current state of the economy. For instance, economic downturns, recessions, or instability can cause demand for commercial properties to drop off, resulting in lower rental rates and a widespread reduction in property values.
  • Interest Rate Risks ➝ The interest rate risks, or financing risk, refers to the ease (or difficulty) of obtaining loans to fund the acquisition of a property. Debt financing, or the use of borrowed funds, is an integral component of CRE investing, so the pricing and availability of commercial loans is a critical driver of the deal activity in the CRE market (and the profitability of property investments)
  • Liquidity Risk ➝ The CRE sector is generally more illiquid than residential real estate, considering the fewer potential buyers. Therefore, an investor’s capital can be tied up for a longer period, which reduces the internal rate of return (IRR) of CRE investment funds since a longer hold period cuts into an investment’s IRR.
  • Operational Risks ➝ Commercial property management involves higher maintenance costs due to larger spaces and specialized systems like HVAC, elevators, and amenities. Property management issues, such as disputes with commercial tenants, can emerge, which is a far more complicated process than a residential tenant missing a mandatory payment (and defaulting).
  • Geographic and Location-Specific Risks ➝ The location of a commercial property is an influential factor with broad implications on the valuation of such properties. For example, factors such as local economic conditions, population growth, near-term trends (e.g. Miami), and developments (e.g. Amazon HQ) can cause significant swings or declines in the valuation of nearby properties.

Q.  Are Property Taxes Included in NOI?

Contrary to common misconception, property taxes are, in fact, included in net operating income (NOI).

Why? NOI is a measure of operating performance, and property taxes are an operating expense in the commercial real estate industry.

However, income taxes paid to the government are NOT included in NOI.

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