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Familiarizing yourself with these terms will help you make a good investment
Purchasing and financing Commercial Real Estate is significant decision that can affect your business, positively or negatively, for decades to come. This is why it’s so important to get a good CRE on your team to help you find the right property.
But, as everyone who looks at a Commercial Property listing for the first time finds out, there’s a lot of industry jargon that doesn’t help you figure anything out – like the price and details about a property.
With that in mind, we thought we’d compile a glossary of terms that you should know to translate CRE listings into plain English.
How is Commercial Rent Calculated?
When you look at a listing, you’ll see that the price is set per square foot per year.
So, if it’s $11 a square foot and a 2,200 square foot space, the rent would be $24,200 a year.
What is a Capitalization Rate (Cap Rate)?
Basically, the Cap Rate is a commonly used metric to normalize properties and compare potential returns of different properties. The Cap Rate is the percent return you can expect from a property in its first year. You get it by dividing the net operating income (NOI) by the sale price.
So, if you’re looking at investment properties and a building’s asking price is $10 million, its Cap Rate would be 10% if it produces $1 million in income a year.
What is the Debt Coverage Ratio (DCR)?
The Debt Coverage Ratio is the other side of the coin from the Cap Rate. It is figured by dividing the mortgage payments by the NOI. When you figure out the two of them together, you can see how profitable a potential property would be at the asking price, and what sale price is necessary to make it a good deal.
For example, if it costs $750,000 a year to service the mortgage on that $10 million property with a NOI of $1 million, the DCR would be 1.3.
What is the Internal Rate of Return (IRR)?
The IRR is a metric to measure the profitability of a potential investment. In short, it is the percentage rate earned on each dollar invested for each period it is invested.
For example: let’s say you purchase the $10 million dollar property and at the end of the year your profit is $250,000. Your IRR for the year would be 2.5%. Then, if you earn that $250,000 a year for four years and sell the building for $11 million at the end of the fourth year, you’ll have earned a profit of $2 million over four years, which adds up to an annualized IRR of 5%.
What are Capital Expenses (Cap Ex)?
Capital expenses include improvements (not necessarily repairs) to a fixed asset that increases the value or life of that asset. A capital expenditure is typically amortized or depreciated over the useful life of the asset, as opposed to a repair, which is expensed in the year incurred.
What is a Core Investment?
A core investment refers to an investment in a high-quality real estate asset that is located in a highly accessible and highly desirable submarket. For example, a core investment is an asset that is at least 80% leased, carries long-term leases with credit-worthy tenants, and is among the most sought-after assets in the market.
What is a Value Add Investment?
A value add investment is an investment in a real estate asset with existing cash flow (and value) that can be increased by raising occupancy, rents, or both. To add value to a property, owners typically improve or replace building systems, provide new finishes, introduce new amenities, improve access or circulation to the building, or add square footage.
What is a Triple Net Lease (NNN)?
In a triple net lease, also referred to as a net-net-net or NNN, a tenant pays all operating expenses, taxes, and insurance. Landlords are responsible for the structure, roof, and sometimes the parking lot.
Familiarizing yourself with these CRE terms will help you decide which property is the best investment for you. RealMassive offers detailed and transparent CRE listings, so that you have all the information you need to select your property.