Hi,
Can anyone list some lingo terms that I should know and understand while investing in commercial real estate ? Can anyone list any interest sites that might help me ?
Thanks
If you look to the left, there is a link to an investing glossary.
You can also check out:
http://www.all-about-commercial-mortgages.com
Regards,
Patti
Thank you
There’s many terms that you should know. Here is just a few:
Cap Rate
Vacancy
NOI
net cash flow
debt service
know about leases
loan to value
etc
Debt Coverage Ratio
Also known as Debt Service Coverage Ratio (DSCR). The debt coverage
ratio is a widely used benchmark which measures an income producing
property's ability to cover the monthly mortgage payments. The DCR
is calculated by dividing the net operating income (NOI) by a property's
annual debt service. Annual debt service equals the annual total of all
interest and principal paid for all loans on a property. A debt coverage
ratio of less than 1 indicates that the income generated by a property
is insufficient to cover the mortgage payments and operating expenses.
For example, a DCR of .9 indicates a negative income. There is only
enough income available after paying operating expenses to pay 90% of
the annual mortgage payments or debt service. A property with a DCR
of 1.25 generates 1.25 times as much annual income as the annual debt
service on the property. In this example, the property creates 25% more
income (NOI) than is required to cover the annual debt service.
Example: We are considering buying an investment property with a net
operating income of $24,000 and annual debt service of $20,000. The
DCR for this property would be equal to 1.2. This means that it generates
20% more annual net operating income than is required to cover the annual
mortgage payment amount.
Net Operating Income $24,000
Debt Coverage Ratio = ------------------------------ = ----------- = 1.2
Annual Debt Service $20,000
Many lending institutions require a minimum debt coverage ratio value to
procure a loan for income producing properties. DCR requirements for
lending institutions may vary from as low as 1.1 to as high as 1.35. From
a lending institutions perspective, the higher the debt coverage ratio value,
the more income there is available to cover the debt service and thus the
less the risk.
Net Operating Income (NOI) is calculated as follows.
Income
Gross Rents Possible 35,000
Other Income 2,000
Total Gross Income 37,000
Less Vacancy Amount 3,000
Gross Operating Income 34,000
Less Operating Expenses 10,000
Net Operating Income 24,000
Operating Expenses include the following items; advertising, insurance,
maintenance, property taxes, property management, repairs, supplies, etc.
Lenders use the debt coverage ratio to determine if an income producing
property has sufficient income to cover the operating expenses and debt
service. To acquire a loan for an income producing property, the debt
coverage ratio must usually be greater than 1.1 and most lenders require a
Cap Rate - Capitalization Rate
The Capitalization Rate or Cap Rate is a ratio used to estimate the
value of income producing properties. Put simply, the cap rate is the
net operating income divided by the sales price or value of a property
expressed as a percentage. Investors, lenders and appraisers use the
cap rate to estimate the purchase price for different types of income
producing properties. A market cap rate is determined by evaluating
the financial data of similar properties which have recently sold in a
specific market. It provides a more reliable estimate of value than a
market Gross Rent Multiplier since the cap rate calculation utilizes
more of a property's financial detail. The GRM calculation only
considers a property's selling price and gross rents. The Cap Rate
calculation incorporates a property's selling price, gross rents, non
rental income, vacancy amount and operating expenses thus providing
a more reliable estimate of value.
If we have a seller and an interested buyer for particular piece of
income property, the seller is trying to get the highest price for the
property or sell at the lowest cap rate possible. The buyer is trying to
purchase the property at the lowest price possible which translates into
a higher cap rate. The lower the selling price the higher the cap rate.
The higher the selling price, the lower the cap rate. In summary, from
an investor's or buyer's perspective, the higher the cap rate, the better.
Investors expect a larger return when investing in high risk income
properties. The Cap rate may vary in different areas of a city for many
reasons such as desirability of location, level of crime and general
condition of an area. You would expect lower capitalization rates in
newer or more desirable areas of a city and higher cap rates in less
desirable areas to compensate for the added risk. In a real estate
market where net operating incomes are increasing and cap rates are
declining over time for a given type of investment property such as
office buildings, values will be generally increasing. If net operating
incomes are decreasing and capitalization rates are increasing over
time in a given market place, property values will be declining.
If you would like to find out what the cap rate is for a particular type of
property in a given market place, check with an appraiser or lender in
that area. Be aware that the frequency of sales for commercial income
properties in a given market place may be low and reliable capitalization
rate data may not be available. If you are able to obtain a market cap
rate from an appraiser or lender for the type of property you are
evaluating, check to see if the cap rate value was determined with
recent sales of comparable properties or if it was constructed. When
adequate financial data is unavailable, appraisers may construct a cap
rate through analysis of its component parts thus reducing the credibility
of the results. Cap rates which are determined by evaluating the recent
actions of buyers and sellers in a particular market place will produce
the best market value estimate for a property.
If you are able to obtain a market cap rate, you can then use this
information to estimate what similar income properties should sell for.
This will help you to gauge whether or not the asking price for a
particular piece of property is over or under priced.
NOI NOI
Cap Rate = -------- Estimated Value = -------------
Value Cap Rate
Example 1: A property has a NOI of $155,000 and the asking price
is $1,200,000.
$155,000
Cap Rate = -------------- X 100 = 12.9 rounded
$1,200,000
Example 2: A property has a NOI of $120,000 and Cap Rates in the
area for this type of property average about 12%.
$120,000
Estimated Market Value = ------------ = $1,000,000
.12
Net operating income is determined by subtracting vacancy amount and
operating expenses from a property's gross income. Operating expenses
include the following items: advertising, insurance, maintenance, property
taxes, property management, repairs, supplies, utilities, etc. Operating
expenses do not include the following items; Improvements such as a new
roof, personal property such as a lawn mower, mortgage payments,
income and capital gains taxes, loan origination fees, etc.
Appraisers use the Income Approach, Cost Replacement and Market
Comparison methods to estimate the value of property. The Income
Approach utilizes the theory of Capitalization.