How commercial real estate market analysis drives better investment decisions

Imagine you find the perfect commercial property: nice location, attractive price, and a motivated seller. However, without comprehensive market analysis, you could be investing blindly. 

What is commercial real estate market analysis?

Commercial real estate market analysis is the systematic evaluation of market conditions, trends, and property performance in a specific geographic area. Think of it as due diligence for the local market as a whole, not just the individual property in question. 

Whether you plan to acquire, develop, or sell a commercial property, a firm understanding of its local real estate market is essential to making a wise investment decision.

Bottom-up vs. top-down analysis

There are two main ways to approach real estate market analysis: from the bottom up or from the top down:

Bottom-up analysis	Top-down analysis
Starts with macroeconomic trends, then narrows to regional/local markets, then specific properties	Starts with individual properties and zooms out to portfolio and market-level considerations

Why commercial real estate market analysis matters

Good real estate market analysis can help you:

• Identify growth opportunities. Emerging and expanding markets can be excellent targets for buying and holding commercial property. 

• Anticipate market risks. Get early warnings of oversupply of commercial buildings, economic downturns, or a drop-off in tenant demand. 

• Secure financing. Lenders prefer financing properties that will benefit from strong market tailwinds. As a result, strong market analysis can help you qualify for a loan.

• Negotiate with buyers and sellers. Accurate market data can help you negotiate a better deal when acquiring or selling commercial real estate properties. 

• Make better investment decisions. Analyzing market trends can help you determine when to enter or exit investments and how to allocate your portfolio. 

Key components of commercial real estate market analysis

Here are the key ingredients of a comprehensive real estate market analysis: 

Macroeconomic indicators

Macroeconomic indicators tell you about the broader economy and its potential impact on your investment. They include metrics like GDP growth, interest rates, inflation, unemployment rates, and consumer confidence scores. 

Demographic and population trends

Demographic trends reveal who lives and works in your market and how that may change over time. They include metrics like population growth rates, age distribution, household income levels, migration patterns, and educational attainment.

Supply metrics: Stock, vacancy, pipeline

Supply metrics show you what real estate is currently available and what’s coming to market. They include total inventory or stock, vacancy rates (percentage of unoccupied space), and the development pipeline (projects under construction or planned). 

Demand metrics: Absorption, employment

Demand metrics measure how quickly space is being leased and what’s driving that demand. They include net absorption (the change in occupied space over time), employment growth in key industries, and job creation rates.

Pricing, rent trends, and cap rates

Pricing, rent trends, and cap rates tell you what properties cost and what income they generate. They include average asking and effective rents, rent growth rates, sale prices per square foot, and capitalization rates (the ratio of net operating income to property value).

Risk and sensitivity analysis

Risk and sensitivity analysis helps you understand potential downsides and how different scenarios might affect a market. This includes stress testing your assumptions around occupancy, rent growth, and exit cap rates, as well as evaluating market-specific risks.

How to conduct a commercial real estate market analysis step-by-step

To conduct a real estate market analysis, follow these steps: 

1. Define objectives and scope

First, set a goal for your market analysis. Do you want to see if a market is suitable for a particular property type (office, retail, multifamily, etc.) or investment strategy (rental, flip, etc.)? Then set parameters around city, property type, and timeframe to narrow your analysis. 

2. Gather demographic, economic, and property data

Next, collect demographic, economic, and property data from reliable sources, such as the Bureau of Labor Statistics (BLS), the U.S. Census Bureau, and real estate data platforms like CoStar and RealPage. 

3. Assess supply and demand dynamics

Armed with the relevant data, start analyzing supply and demand trends. For example, look at historical vacancy and absorption rates to gauge demand, and planned construction projects and delivery schedules to estimate inventory levels. 

4. Model projections and forecasts

Build financial models with spreadsheets or dedicated software like Agora to project a market’s average rental rate growth. Stress test the model by adjusting assumptions based on optimistic vs. pessimistic scenarios. 

5. Interpret and report insights

Once you’ve thoroughly analyzed the market, synthesize your findings into actionable insights. For example, you could create a report that highlights key risks and opportunities along with your confidence level on different investment approaches. 

Challenges and limitations of commercial real estate market analysis

Of course, no market analysis is perfect. Here are some commercial real estate challenges and limitations to consider: 

• Assumption bias. Overly optimistic projections for rent growth or occupancy can skew your analysis. The same goes for leaning too heavily on past performance. 

• Data gaps. Incomplete transaction data, lag time in public data releases, and unavailable proprietary data can hamper your ability to analyze a market. 

• Time and cost factors. Collecting and analyzing market data can take a lot of time and money. If you’re not careful, the cost could outweigh the benefits. 

Best practices in commercial real estate market analysis

To get the most out of your real estate market analysis, follow these best practices: 

Use reliable and current data sources

Your market analysis is only as good as the data you use. Subscribe to institutional-grade data platforms for the most accurate and current data and verify it across multiple platforms. 

Validate assumptions and stress test models

Test the market’s sensitivity to key variables like vacancy, rent growth, cap rates, etc. That way, you have a better idea of how a market will perform under ideal and worst-case scenarios. 

Cross-check insights using multiple methods

Conduct your market analysis with quantitative analysis, broker interviews, physical site visits, and other methods. Then cross-check insights from each against the other. 

Present findings visually with dashboards and charts

Illustrate geographic trends with heat maps and changes over time with line graphs. To compare transactions within a market, create data tables. 

Update analysis periodically

Market conditions can change without notice. Regularly review and update your analysis accordingly. You may also want to establish specific triggers for re-analyzing a market, such as a sudden change in rental rates, vacancy rates, etc. 

Current trends in the commercial real estate market

According to JPMorgan, the top nationwide commercial real estate trends include the following:

• Industrial real estate market remains strong
• Some office markets may be normalizing
• Retail sector stays steady
• Overbuilding of multifamily

Check to see how these trends are impacting your target commercial real estate market outlook and lending trends.

Technology and data tools used in commercial real estate market analysis

Fortunately, you don’t have to analyze commercial real estate markets from scratch. Plenty of technology and data tools can help streamline the process. 

For example, Agora includes analytics for your property portfolios along with automated waterfall modeling features. By streamlining your market analysis workflow with Agora and other tools, you can save time and effort and seize investment opportunities faster. 

Conclusion

Ultimately, good real estate market analysis can turn guesswork into an informed strategy. 

By systematically evaluating market conditions, supply and demand dynamics, and other economic indicators, you can identify investment opportunities and avoid costly mistakes. However, this process requires effort and the right tools. 

Start with a clear goal and then leverage quality data sources and software like Agora to achieve the best results.