What are some commercial real-estate terms you need to know? Well, today I am going to give you seven of them. It is very important you know these terms no matter what you’re buying – an office, warehouse, apartment, and especially if you want to be a commercial real estate investor.
1. LOI – A letter of intent is a written summary of the key deal terms of a contemplated transaction that focuses on two types of commercial real estate transactions: (1) purchase and sale transactions and (2) lease transactions. You can make a lot of offers because it is only 1 to 2 pages long and free. There should also be no fear in making lots of offers because it is not legally binding.
2. LTV – Loan-to-value ratio is a figure that measures the value of a loan against the value of the property. A lender calculates LTV by dividing the amount of the loan by the lesser of the property’s appraised value or its purchase price. For example, the LTV for a $90,000 loan on a $100,000 property would be 90% ($90,000 ÷ $100,000 = 0.9, or 90%). For both commercial and residential loans, borrowers with lower LTVs will qualify for more favorable financing rates than those with higher LTVs. The reason: They have more equity (or stake) in the property, which equals less risk in the eyes of the lender.
3. DCR – If a property has a debt coverage ratio of less than 1, it is actually losing money, which means that it will be ineligible for most kinds of commercial real estate financing, except for perhaps hard money loans or other types of high-interest, emergency loans. In general, most lenders prefer a DCR/DSCR of at least 1.20x. However, certain types of loans will go below this. It is important to realize that lenders often require riskier types of properties to have significantly higher DCR. For instance, most lenders prefer hotel and self-storage properties to have a DCR of at least 1.40x, due to the fact that these property types have incredibly high turnover and revenues that can fluctuate greatly by season (and even by the day).
4. NOI – In real estate investing, net operating income is the amount of income collected from an investment property after you subtract the operating expenses and vacancy losses. Real estate investors look at a property’s net operating income to determine if the property is a good investment. They also analyze the NOI of a property that they already own to help determine if they need to raise rents to increase their cash flow. Unlike with the cap rate, there isn’t a “good” NOI. Instead, investors can compare the NOIs between properties and use the current NOI to see if their expenses are too high, rents too low, or if the property is unaffordable once they add in their mortgage payment.
5. Cap rate – A capitalization rate, or cap rate, is used by real estate investors to evaluate an investment property and show its potential rate of return, helping decide if they should purchase the property. The cap rate formula is cap rate = net operating income/current property value. A good cap rate is typically higher than 4 percent. A cap rate is an important tool for investors because it helps them evaluate real estate based on its current value and its net operating income (NOI). It gives them an initial yield on an investment property. An investor can look at a rising cap rate for a property and see that there’s a rise in income relative to its price. In contrast, a fall in cap rate generally indicates that there is a lower rental income compared to its price. They can look at the cap rate before deciding if the property is worth buying or not.
6. COC – A cash on cash return calculation determines the amount of annual income an investor earns on a piece of commercial real estate when compared to the amount of cash invested. The cash on cash return can vary greatly on the same real estate depending on how an investor finances the property. This financial metric is particularly significant in the commercial real estate industry because of the nature of the transactions in the industry. In most cases, investments in properties are carried out using a large amount of debt. Therefore, the return on investment (ROI) calculation loses its relevance because it accounts for all the money invested, including debt. On the contrary, cash on cash return excludes debt and evaluates only the actual cash amount invested. In such a scenario, an investor can obtain a more precise performance of his investment.
7. GRM – A gross rent multiplier is defined as the number of years a property would take to pay for itself in gross rent without taking into account insurance, property taxes, utilities, and other expenses. If an investor is considering a property but thinks that it may be overpriced, they can use a GRM to estimate an appropriate price for the property. This assumes they know the average GRM for that property type in the area and the property’s rent roll.
Do you have questions about Tampa? Are you interested in commercial real estate in Tampa? Contact me today!