Calculating Commercial Property Values1


Published on

This is a simple easy to understand presentation for determining commercial property value.

Calculating Commercial Property Values1

  1. 1. Calculating Commercial Property Values Crash Course In Commercial Real Estate
  2. 2. 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>
  3. 3. 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>
  4. 4. 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
  5. 5. 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.
  6. 6. 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>
  7. 7. 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)
  8. 8. 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.
  9. 9. 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%).
  10. 10. 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 .
  11. 11. 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).
  12. 12. 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....
  13. 13. 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.