If you plan on investing in commercial real estate you should know the following terminology:
- Net Operating Income (NOI)
- Cash and Cash Return (ROI)
- Capitalization Rate (Cap Rate)
- Debt Coverage Ratio (DCR)
- Price Per Unit
- Building Classification
- Types of Leases
Net Operating Income (NOI)The net operating income calculation is NOI is equal to your gross rental income minus your expenses. NOI = Rental Income less Expenses
Cash and Cash Return (ROI)
Also known as your ROI, return on investment which is basically your annual cash flow divided by your down payment.
Capitalization Rate (Cap Rate)
A cap rate is used to measure a building’s performance without considering the mortgage financing. Cap rate = NOI divided by sales price.
A high Cap Rate = High Risk
Debt Coverage Ratio (DCR)
This is a term used frequently with your lenders. When you think of commercial real estate and you think of financing, at the heart of commercial real estate and financing is the DCR. It’s defined as the amount of cash flow available to pay your mortgage
NOI divided by your annual debt service (which is your annual mortgage payments) So DCR is equal to NOI divided by your 12 months of mortgage payments. If it equals to 1.0 you have no excess cash flow.
Price Per Unit
This term is at the heart of where to start in determining what a property is worth and also what to offer when you’re considering buying a property, so basically the price per unit and price per square foot.
Price per unit is used that for apartments (i.e. if you have a $500,000 apartment building with have 10 units in it, that’s $50,000 a unit. Price per unit.)
Price per Square Footage
The same calculation is used on square footage. We used price per square foot in office buildings and retail centers, industrial and commercial properties (i.e. if you have a 3,500 sq. ft. industrial condo selling for $500,000 than the price per sq. ft. is $142.86. Price Per Square Foot).
Most prestigious buildings competing for premier office users with rents above average for the area. Buildings have high-quality standard finishes, state of the art systems, exceptional accessibility and a definite market presence.
Buildings competing for a wide range of users with rents in the average range for the area. Building finishes are fair to good for the area. Building finishes are fair to good for the area and systems are adequate, but the building does not compete with Class A at the same price.
Buildings competing for tenants requiring functional space at rents below the average for the area.
Types of Leases
Leases are written legal agreements between the property owner and tenant.
Apartments: we have one year or month-to-month leases. They’re all written by our lawyers and are strong legal documents. You are in the revenue business and have to give you the right to collect rent and evict people if need be.
Office Buildings/Shopping Centres: we can have 3 types of leases full-service lease where the landlord pays for everything, the triple net lease where the tenant pays for everything and the modified gross lease where it’s halfway between the full service and the triple net lease.
So it boils down to lease agreements are important – and should be written by a solicitor if possible. Commercial leases should be negotiated by a trained professional such as your local commercial real estate agent.
As for investment advice – your local commercial brokerage firm is an ideal place to start on your way to becoming a savvy commercial real estate investor!