Evaluating Commercial Real Estate – 3 Key Metrics
When you decide to invest in commercial real estate, you have numerous options to choose from. Comparison of location and size for similar properties, like office spaces, it’s straightforward. Yet, how do you evaluate different types of assets, like industrial warehouses and shopping malls? How do you know you have taken the right decision when comparing apples to oranges? The answer is metrics, reduce everything down to numbers and compare those. Here is a selection of key industry terms.
Net Operating Income (NOI)
Any commercial property should generate revenue. As an investor, you are interested in the net income. That is the value you get after you pay the operational expenses. Simply put, add all revenue sources like rents, leases, publicity contracts, and parking spots to compute the income. Then, add all your expenses, including utility bills, insurance, facility management, taxes, repair, just not your mortgage. The NOI is the difference between the two. Of course, a negative NOI is a major red flag and shows an unsustainable model. The higher the NOI, the better the investment.
If you subtract the mortgage from the NOI, you get the cash flow, a secondary metric.
Commercial property is all about cash velocity. You want to get your money back fast to be able to invest it in something else. This is precisely what this metric tells you. Getting your money back in the first year is 100% rate, while in four years you get only 25%. Compute the ratio of pre-tax annual cash flow and divide it by the invested amount. The cash-on-cash return indicator shows if a property is a great long-term investment or if it is being sold under its market value. This metric provides an accurate evaluation of the performance of the actual cash invested, not taking into consideration the loans.
Capitalization Rate (CAP Rate)
Computing the cap rate means dividing the NOI by the sales price of the property. This evaluates what would your return be if you paid for everything and had no mortgage involved. It is also a way to evaluate the neighborhood. It helps you estimate how much you will likely get out of your investment. The accurate computation is only for the first year, when you know the sales price, for the next ones you will need to have your property valued by an expert.
Did your real-estate agent present you with these numbers? If not, you are not taking an informed decision. Call us today at 301-655-8253 or visit our website to learn more about how Douglas Commercial can help you.