Friday, June 15, 2007

Commercial Real Estate Terminology - What does this stuff mean???

For those of you looking to get into commercial real estate investment there is a whole set of "commercial real estate words" you are going to need to know before you get started. There are actually whole books published on commercial real estate terminology but here are a few of the more commonly used terms as simply as I can put them.

NOI - Net Operating Income - How much money you earn usually expressed on an annual basis after you pay your expenses but before you pay your mortgage or your income taxes

Cash on Cash Return - Expressed as a percentage, it's the rate of return you earn on the actual cash you put as a down payment. Divide the NOI (see above) by the amount of cash you put as a down payment. $10K NOI divided by a $50K cash down payment = a cash on cash return of 20% (not too shabby)

Cap (Capitalization) Rate - A term used to express the value of a property assuming it was an all cash purchase. As an example, from the buyer's standpoint if you want to earn a 10% return on your investment and you have $1M cash to spend, you would buy a property with an NOI (see above) of $100K/year. $100K NOI divided by a 10% Cap Rate = $1M in value. Now the same person with $1M to spend but wants to earn a 15% return would need to find a property that makes $150K/year.

GRM (Gross Rent Multiplier) - A useless term as far as any investment in New England goes from what I can tell but in case you are outside New England and you see it, here goes...basically it's a way to value a property by taking the gross annual rent (assume for now the rent will never increase or decrease) and figuring out how many years the property will take to pay for itself. A property purchased for $1M with $200K of annual gross rent will take 5 years to pay for itself so it has ha GRM of 5. Another property that is also on the market for $1M but only has annual gross rents of $100K will take 10 years to pay for itself so the GRM is 10. The lower the GRM the better so the first investment is the better option.

Debt Service - The total dollar value of all your mortgage payments for a whole year including Principal and Interest. It's the amount of money needed to "service" the annual debt of the property

LTV (Loan to Value Ratio) - The ratio of the overall value of the mortgage to the overall value of the property. $1M property with a $750K mortgage has an LTV of 75%

Again...there are literally thousands of terms that you will come across in your analysis of commercial real estate investments so my advice is to start everything you can and then read it again...

Please don't buy commercial real estate or any real estate for that matter without first seeking out the help of a qualified real estate professional.


Jennifer said...

I'm a residential professional with clients interested in investing in commercial property. Who do I call? The commercial professionals. Since my job is to make sure my clients get the best service, that is the only way to go. Thanks for all the great information.

Beland said...

I appreciate you stopping by Jennifer...

I'd be happy to speak with any of your residential clients that may have questions about investing in commercial real estate. Let me know if there is any specific areas of commercial real estat you would like me to address.