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Calculating Commercial Property Values Crash Course In Commercial Real Estate

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Commercial real estate, pricing is determined by the income the property produces . <ul><li>Commercial Real Estate Terms </li></ul><ul><li>Example </li></ul>

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Commercial Real Estate Terms <ul><li>Gross Rent = Yearly gross rental income from all units </li></ul><ul><li>Gross Income = Gross Rent - vacancy factor + other income (for example, laundry) </li></ul><ul><li>Net Operating Income (NOI) = Gross Income - all expenses EXCEPT DEBT SERVICE! </li></ul><ul><li>Cap Rate = NOI/Sales Price </li></ul><ul><li>Cash Flow = NOI - debt service </li></ul>

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Example: Sales Price & Income Sales Price: $90,000 Income: Gross Rent: $400/unit * 6 units * 12 months = $28,800 Vacancy: 10% vacancy = ($2,880) Other Income: Laundry = $500 ------------------------------------------------------- Total Gross Income: $26,420

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Example: Expenses Gas = $480 Electricity = $300 Management = $3,274 Taxes = $1,160 Insurance = $750 Water = $2,400 Maintenance = $3,000 ------------------------------------------------------- Total Expenses: $11,364 (43% of Gross Income) You are in the ballpark on expenses if it's between 40-50% of gross income.

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Example: Net Operating Income (NOI) <ul><ul><li>Net Operating Income (NOI) = Gross Income - all expenses EXCEPT DEBT SERVICE! </li></ul></ul><ul><ul><li>$26,420 (Total Gross Income) − $11,364 (Total Expenses ) </li></ul></ul><ul><li>$15,056 (NOI) </li></ul>

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Example: Cap Rate % Cap Rate stands for &quot;capitalization rate,&quot; and it is basically the yield on your investment if you bought a property with all cash. In this case, if I took $90,000 of my own money and bought this property, then every year I would receive $15,056 , which is a yield of 16.7% . Cap Rate = (NOI/Sales Price) $15,056 (NOI) $90,000 (Sales Price) 16.7% (Cap Rate)

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Example: Cap Rate - Conclusion The reason you can tell this is a good deal is because I can borrow most of this money at a substantially lower rate (8-10%). Basically, anything that has a cap rate in the teens is a good deal.

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Example: Cap Rate - Conclusion What you typically find is that in any one particular market, the cap rate doesn't change a whole lot. In a well established neighborhood with high demand, you'll probably be hard pressed to find a cap rate above 10% (which leaves a very thin spread when you borrow money at 8-10%).

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Example: Cap Rate - Conclusion By taking the average cap rate for a particular area, you can quickly determine the market value of a commercial property (NOI/cap rate = value). So if the property I just bought was in a place with an average cap rate of 15%, then the market value would be $15,056/.15 = $100,000 .

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Example: Cap Rate - Conclusion To complete the example, if the buyer borrowed $82,500 at 12% interest for 20 years we get: Debt Service: $908 * 12 months = $10,896/yr (mortgage ) Cash Flow: $15,056 - $10,896 = $4,160 ($347/month).

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Example: Actual ROI • (Cash-On-Cash) One final useful calculation is the actual ROI or return on investment (usually called cash-on-cash). This is the amount of money I'm getting for my out-of-pocket expense. In this case, making a down payment of $7,500, and receiving $4,160 a year. This is an annual ROI of 55.5% (Notice that if one can structure a no money down deal, your ROI is infinity....

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Example: Conclusion If you continue to play with the numbers, you can see why there can be such a great difference in a cap rate of 10% and a cap rate of 15%. In this example, since borrowing money at 12% interest, any increase in cap rate above 12% means that that percentage of the purchase price goes right into my pocket. So we have: 16.7% - 12% = 4.7% , and 4.7% of the $90,000 purchase price is $4,230 . This is very close to the previous annual cash flow.