Learn Commercial Real Estate Vocabulary
There's a lot of vocabulary and acronyms in commercial real estate that you're likely unfamiliar with. It's helpful to be savvy on some of the terms. This will make this process and working with people in the industry easier.
Here are some common terms to get started with:
Loan-To-Value (LTV): A ratio of how much money you're asking from a lender vs. the total value of what you want to purchase.
Debt Service Coverage Ratio (DSC): Operating income over total debt service. Basically how much of the debt you'll be able to cover each year with income.
Capitalization Rate (Cap Rate): Income of the property divided by the total value of the property.
Cash on Cash: Annual income over how much you actually invested. The amount invested could be just the amount your down payment was.
Vacancy Rate: Percentage of properties that are vacant in a time period in a given area.
Usable vs. Rentable Square Feet: See this excellent article we have on the difference between these.
Ad Valorem: A tax based on the assessed value of a piece of property.
These are just some of the terms to be familiar with.
3 Types of Leases for Office Buildings and Shopping Centers:
Full Service Lease: The tenant pays a flat fee and landlord pays for everything, including insurance, taxes, repairs and utilities.
Triple Net Lease: The tenant pays for everything. This is a passive option, where the landlord only has to pay the mortgage. Watch my video Truth Behind Triple Net Lease to learn more.
Modified Gross Lease: The tenant and landlord split certain expenses.
Net Operating Income (NOI)
The first of 7 commercial real estate terms you must know is Net Operating Income, also known as NOI. The net operating income calculation is NOI is equal to your gross rental income minus your expenses.
NOI = Rental Income - Expenses
Those expenses do not include mortgage payments or depreciation; but specifically property expenses. NOI is at the heart of every commercial real estate deal you'll ever evaluate. It will determine the property worth now and in the future, what your cashflow will be, and how you will make an offer. It's important because as the NOI increases, the property value will increase as well. If the NOI goes down, the property value goes down. We teach our students to find deals with net operating income upside. Meaning, they find ways to get the NOI to go to a new and higher level over two or three years.
Commercial Cash Out Refinance:
This leads me to a technique of all commercial real estate syndicators and our students. It's called the commercial cash out refi. To learn more you can read my blogpost called Commercial Cash Out Refi. It's basically buying a commercial property, increasing the NOI through rent increases and spends reductions, and then refinancing the loan to pull out the original down payment or your investor's down payment while keeping the property. Let me ask you this. After you put your money in, you fix at the property, refi, you take your money out, what is your return on investment if you have no money in? It's infinity. That's the power of the NOI.
Cash On Cash Return
Cash on cash return is also known as your ROI, or return on investment. It is the heart of your money or your investor's money and is basically your annual cash flow divided by your down payment.
Return on investment or your ROI is a very important term because it's not how much money you spend on the property, but how fast your money is coming out of the property. If all you have is $50,000 to spend and it takes 20 years to get back your $50,000 through cash flow, that's not too exciting. That's only a 5% return. Perhaps that's okay for a stock broker, but not for us in commercial real estate. We are expecting a double digit return minimum. Instead, it would be better if you could earn back your $50,000 down payment in three years.That's a 33% return on investment and that's good and very doable in commercial real estate.
When you can achieve a 33%, or sometimes even 50% return on investment, it is because you are working on what we call value added opportunities and that is what we focus on here in our company. Value add commercial properties. Another thing I want to share with you is when you are raising capital from an investor, how you determine what you can pay them is your cash and cash return, because it comes straight off the top. That's why it's really important to know this term.
Commercial Real Estate is a Relationship Based Business
There's a saying that you have probably heard, "No one cares how much you know until they know how much you care." That is so true in commercial real estate, with commercial property owners and brokers as well. Study the terms and know them, but I want you to start with relationships first. Commercial real estate is a relationship based business. I want you to build relationships with brokers, sellers, mentors, and other successful people. That's where success happens first.