If you’ve made the decision to start to invest in commercial real estate there are a number of terms to familiarize yourself with. We’ve discussed at length the different types of commercial real estate. Once you find the right fit for your investing needs you’ll need to become familiar with the kinds of financial metrics that will best help you assess your investing opportunities.
Net Operating Income (NOI)
The NOI of a commercial real estate property is the total income that the property generates, after the expected expenses. It does not include loan costs. NOI is calculated by evaluating the property’s first year gross operating income, minus the operating expenses for the same year. The higher NOI, the higher potential income. Obviously a negative NOI is an investment to be avoided.
Cash flow is the metric you’ll be most interested in, as it determines your expected profit from the property at the end of the year. It’s a secondary metric of NOI. It’s a simple calculation of income minus expenses. The larger your loan, the smaller your cash flow. This will tell you if the property is a good long-term investment or not. The smaller the percentages, the longer the ROI for the property. For example a 100% rate means you’ll break even in the first year.
You’ll want to pay close attention to the cap rate if your investment includes multiple tenants, like a strip mall, apartment, or office building. The capitalization rate determines the value of these kinds of properties, separate from the buyer and financing. The cap rate is calculated by vacancy, credit losses, other income, and operating expenses, and doesn’t factor in loans. The cap rate will also help you evaluate the entire neighborhood, important for many commercial investments like retail.
Cash on Cash Return
Cash on cash is used by most investors who rely on financing on their purchases. COC compares the first year performance of similar properties. It is related to the amount of money that you put down on the investment and will measure, dollar for dollar, the return to expect on the investment property. It may also be refereed to as a “cash yield” and is commonly used for investments with long-term debt borrowing.