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Important Commercial Real Estate Terms You Should Know
The more you know about the following terms the better prepared you are to make the best decisions regarding buying commercial real estate.
Capitalization Rate (cap rate): The capitalization rate measures a property’s monetary gain without taking into consideration any mortgage financing. The equation for this is net operating income divided by the price you purchase the property for. If you are paying all cash for a property, the cap rate lets you know how much money you are going to make on the property.
Cash Flow: The cash flow is debt service subtracted from your net operating income. In order to identify your monthly profits just divide your annual cash flow by 12.
Cash-On-Cash Return: This is the exact amount of time it takes for your down payment to be returned. The equation for this is: annual cash flow divided by down payment.
Return On Investment (ROI): ROI is a performance measure used to determine the efficiency of your investment, or rather how much money is returned on a real estate investment after all costs are considered. The equation is: ROI= Gain From Investment subtracted by Cost Of Investment, divided by the Total Cost Of Investment. There are many factors that can influence ROI, such as maintenance, interest rates and so forth.
Debt Service: This is your monthly mortgage times 12.
Effective Gross Income: You find your effective gross income by subtracting vacancy from gross income.
Gross Income: This includes all of the income you take in, including rent, vending machines, laundry, etc.
Net Operating Income (NOI): This is perhaps the most important number to consider when deciding if a deal is right for you. To figure out NOI you subtract effective gross income from operating expenses. This is the amount of money left over every month after you take salary and all operating expenses are paid.
Operating Expenses: Annual operating expenses include insurance, taxes, payroll, landscaping, utilities, management fees, payroll, supplies and so forth. You do not include mortgage payments or interest in this number.
Vacancy Rate: Number of vacant units divided by total number of units.
Defining Different Types Of Commercial Property Leases
There are three types of commercial real estate leases. All three of these leases may operate on a “net” or “gross” basis. A gross lease is where the tenant pays a lump sum for rent, and the landlord uses this money to pay all associated expenses. The lure to this type of lease is that the tenant can focus on running their business while the landlord takes responsibility for all building needs, maintenance, etc.
A net lease includes a smaller base rent but the tenant as opposed to the landlord pays most additional expenses associated with the property. A landlord may still cover some additional services with a net lease.
A modified gross lease is a combination of both a net lease and a gross lease.
When signing any lease it’s important to ask which specific services are included in the rent.
Should Your Business Buy Or Rent Commercial Real Estate?
At some point all businesses are faced with the question: to lease or to buy? Buying a property may be right if you have enough capital and are sick of feeling victimized by sky-high rents. When the lease rolls over into a new term, the landlord may jack up prices, putting a strain on your day-to-day operations. If you outright own a property you never have to worry about something like this. Although, there are other expenses you may be faced with as a commercial property owner, such as large-scale repairs and annual property taxes.
There are a few downsides to buying that may make renting more appealing. The location you purchase may be hot today and then not so hot tomorrow, and yet you still own it. Secondly, you don’t want to risk tying up too much capital buying property. If you get into a jam you could always sell the property, but remember that real estate doesn’t always move fast.
Lastly, if you rent out a portion of your space there’s always the risk that tenants will stop paying rent or dip out on a rental agreement, leaving you high and dry. You may also encounter unexpected expenses that could really set you back.
How To Find Prime Commercial Real Estate
Curri Properties is here to walk you through every step, we keep you in the loop at all times regardless what commercial real estate terms you do or don’t know. Our goal is to help you make the best decisions possible earning you the biggest bang for your buck.