Evaluating Commercial
Properties 101
Presented by
Curtis Gabhart and
David Stankaitis, CCIM
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Overview
 Value of Property: What is it and how is it determined?
 Getting to the NOI
 Ok, so I have the NOI, now what?
CAP, GRM, CPU, Cost per SF
 Lending Basics
Leverage, LTV, DSCR
 Cash on Cash Return (ROI)
 Review
 Q&A
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Value of Property
 Definition:
The most probable price (in
terms of money) which a
property should bring in a
competitive and open
market under all conditions
requisite to a fair sale, the
buyer and seller each acting
prudently and
knowledgeably, and
assuming the price is not
affected by undue stimulus.
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Value of Property, cont’d
 As an investor, value is
related to the specific
purpose for which you
have purchased a
particular property.
 For our purposes, we
are going to say that
value is the present
value of the projected
future income stream
or benefits that you
expect to obtain.
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Value of Property, cont’d
Income properties produce income that provides a
stream of cash sufficient to:
• Cash flow not only covers all expenses, but reduces the debt
necessary to acquire the property; and
• Give you a return of your investment plus a return on your
investment.
• Even if the investor chooses to use the property themselves
and pay the necessary operating expenses, taxes and
maintenance themselves, the value of the property is what it
would have cost them to obtain a comparable property as an
investor.
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Value of Property, cont’d
Cash Flow analysis for real estate investments follow a very specific
format:
Gross Scheduled Income
(Minus)
Vacancy and Collection Loss
(equals)
Effective Gross Income
(minus)
Operating Expenses
(equals)
Net Operating Income
The format above does not change, regardless of the type of property.
Therefore, it is important that the practitioner be familiar with the
formula, as well as the definition of each.
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Gross Scheduled Income: The sum of the
expected rent for a particular property. e.g. In
an Apartment building it would be the sum of
the rents from each apartment.
Vacancy: Is calculated as the rent loss due to
empty units. When underwriting the lenders
usually use 5% or the market vacancy factor.
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Effective Gross Income:
Is the difference between the GSI and Vacancy Factor
e.g. If Gross Scheduled Income is $100,000 and vacancy is
5% what is the Effective Gross Income?
GSI $100,000.00
Vacancy $ 5,000.00
EGI $ 95,000.00
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Expenses
• T-U-M-M-I
• Taxes
• Utilities
• Management
• Maintenance
• Insurance
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Net Operating Income
GSI $ 100,000.00
Vacancy $ 5,000.00
EGI $ 95,000.00
Expenses
Taxes $ 15,000.00
Utilities $ 3,450.00
Management $ 5,000.00
Maintenance $ 5,000.00
Insurance $ 5,000.00
Total Expenses $ 33,450.00
Net Operating Income $ 61,550.00
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Pricing Summary
 Calculating the Comparable Benchmarks
 CAP
 GRM
 CPU
 Cost per Square Foot
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Capitalization Rate
– The methodology using Capitalization (CAP) rates to derive value
is known as Direct Capitalization. Symbolically,
CAP = NOI / Price
– For example, if within a specific submarket properties have
recently traded at a 10% CAP rate and a property has an NOI of
$150,000, you can derive a preliminary value estimate of
$1,500,000 by dividing $150,000 by 0.10.
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Capitalization Rate Cont’d
• If the NOI were $100,000 what is the property
worth at a 6% CAP? 7% CAP? 8% CAP?
• $100,000 / 6% = $1,666,667
• $100,000 / 7% = $1,428,571
• $100,000 / 8% = $1,250,000
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Capitalization Rate, cont’d
• A warning about CAP Rate:
• Be careful with the term "CAP Rate". Advertised rates will
vary depending upon the method of calculation. For
example, CAPs can be based on:
– Actual income and expenses from the prior 12 months,
– Projected income and last year's expenses,
– Projected income and last year's expenses inflated by 3.0%,
– Current income and projected expenses,
– Projected income and expenses,
– And for each of these, NOI can be calculated before
or after reserves.
– Click here for more in depth information on CAP
RATES
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Gross Rent Multiplier
 Another method of valuing an income steam is known as the gross
rent multiplier (GRM).
– Sometimes it is also referred to as the gross income
multiplier (GIM).
 This method simply compares the value or sale price of a property
to its gross rental income.
 The gross income that is used will always be gross income, but it
may be figured on an annual or a monthly basis.
 In most cases, the monthly gross rents will be used in small
residential properties almost exclusively.
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Gross Rent Multiplier, cont’d
 Regardless of which type of gross income is used, the calculation
is the same.
– The formula is: Value = Gross x GRM
 This factor must be derived from analysis of comparable property
sales.
– For example, in analyzing a small residential
investment property with a gross annual income of
$12,500. a search of comparable sales indicates the
following data;
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Gross Rent Multiplier, cont’d
The gross rent multiplier for each property may now be
calculated
Value Gross Income GRM
Sale 1 $125,000 $19,600 6.38
Sale 2 $164,000 $26,100 6.28
Sale 3 $110,000 $17,100 6.43
Sale 4 $130,000 $20,000 6.5
Sale 5 $182,000 $30,000 6.07
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Cost Per Unit
 Cost per Unit is a simple market benchmark, derived by
dividing the price by the number of units. Conversely, you
derive the price by multiplying the number of units in a
building by the current market price per unit.
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Cost Per Unit Cont’d
Value Units CPU
$1,000,000 8 $125,000
$1,000,000 10 $100,000
$1,000,000 12 $83,333
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Price Per Square Foot
 The price per square foot is derived by
dividing the price of the property by the
square footage.
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Price Per Square Foot, cont’d
Value S.F. PPSF
$1,000,000 3,300 $303.00
$1,000,000 10,000 $100.00
$1,000,000 2,000 $500.00
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Weaknesses of the Indicators
 The price per unit does not consider the size, type of units, income or
physical condition.
 The price per sq. ft. does not consider the number of units, the type of
units, the income or physical condition.
 Gross Rent Multiplier considers only the Gross Potential Rent (GPR),
not the vacancy, expenses, physical condition or the potential upside
due to below-market rents.
 The CAP Rate considers the net income but not the impact of the
financing or the potential upside due to below-market rents.
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Leverage, cont’d
The principal of using
leverage to your
advantage can be
illustrated fairly simply.
– If you were to invest
$100,000 and receive
a return of $10,000,
then you would have
received a 10% rate
of return ($10,000
return divided by
$100,000 initial
investment).
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Leverage, cont’d
 What if, on the other hand, you were to make the same $100,000
investment, at the same return, using only $10,000 of your own
money while borrowing the balance required from somebody else?
 The return on your investment (not counting interest on the loan)
would be 100% ($10,000 return divided by $10,000 initial
investment).
 This is a simplified example but shows the dramatic effect
leverage can have on total return.
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Loan to Value (LTV)
• The maximum loan amount a lender is willing to lend
expressed as a percentage of the value.
• e. g.75% LTV means the maximum amount a lender
will loan is 75% of the value (or purchase price).
• If the purchase price is $2,500,000 and the max LTV
is 65% what is the maximum Loan Amount?
• $2,500,000 * 65% = $1,625,000
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Debt Service Coverage Ratio (DSCR)
• DSCR is a ratio used by the lender to provide
an income “cushion” to limit loan amount.
• The larger the DSCR the greater the perceived
risk by the lender
• If you are told the DSCR is 1.30:1.00, what
does this mean?
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Debt Service Coverage Ratio (DSCR) cont’d
• The Net Operating Income must be 130% or
1.3 times greater than the annual debt service
payments.
• e.g. If the annual debt service were $100,000
and DSCR were 1.30 to 1.00 what is the NOI?
• $130,000
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Debt Service Coverage Ratio (DSCR) cont’d
• What about the other way? If my NOI is
$100,000 and DSCR is 1.30:1.00 how much do
I have for debt?
• $100,000 / 1.30 = $76,923
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Debt Service Coverage Ratio (DSCR) cont’d
• $100,000 / 1.30 = $76,923
• If the rate is 5% and the amortization is 25
years, how much can I borrow?
• $76,923 / 12 = $6,410 = monthly payment
• Solve for Present Value = $1,096,495
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Debt Service Coverage Ratio (DSCR) cont’d
• Purchase price is $1,000,000, NOI is
$65,000, maximum LTV is 75%, interest rate
is 6%, amortization is 25 years, and the
DSCR is 1.25 to 1.00, how much can be
borrowed?
1. $65,000/1.25 = $52,000
2. $52,000 / 12 = $4333
3. Solve for PV = $672,511 or 67% LTV
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Cash on Cash Return
• Some may refer to this as Return on
Investment or ROI
• ROI = Cash flow after debt service/Investment
• Let’s use the previous example to determine
investment amount ($1,000,000 with max LTV
of 67% = $330,000 investment.
• What is the ROI or Cash on Cash if there is no
debt?
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Cash on Cash Return cont’d
• NOI = $65,000
• Annual Debt Service = $52,000
• Investment = $330,000
• ROI = ($65,000 - $52,000)/$330,000 or 3.94%
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Review
• If the NOI is $150,000, the expenses are 35% of EGI,
and the vacancy factor is 7% what is
• A) The Effective Gross Income?
• B) The Gross Scheduled Income?
• C) If the CAP is 8% what is the purchase price?
• D) What is the GRM given the 8% CAP?
• E) Assume a 1.30 to 1.00 DSCR, a rate of 5%, 30
year amortization, and a maximum LTV of 75%,
what is the maximum loan amount?
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Review Cont’d
• A) EGI = $150,000 / 65% = $230,768
• B) GSI = $230,769 / 95% = $242,914
• C) $150,000 / 8% = $1,875,000
• D) GRM = $1,875,000/$242,914 = 7.72
• E) 150,000/1.3 = $115,385
$115,385/12 = $9615
Solve for PV = $1,791,078 =95% LTV
Max LTV is 75% or $1,406,250
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Questions
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