Like a lot of industries, the commercial real estate business has its own alphabet soup. It’s laden with acronyms and jargon that practitioners need to communicate, peppering speech, documents and articles with shorthand that can make the business look a lot more complicated than it commonly is. What’s ironic is the jargon itself is there to make communication easier and faster, even if it has the opposite effect to the newcomer. You could say that apartment building has a 8% nonleveraged rate of return or you could say it has an 8 cap. Either way, you’re saying the same, even longer, thing: given a set of key assumptions about tenancy and expense and rents, the net income headed to that building’s owner amounts to eight cents a year for every buck she scraped up, borrowed and handed over to buy it.
The financial analysis jargon of commercial property valuation is in part about learning, understanding and portraying those key assumptions. Brendan Erickson, VP of REI Wise (an NAR Commercial Benefits Partner) came to REALTORS® Conference & Expo 2012 to talk about the surprisingly simple principles in valuations lurking in the commercial property alphabet soup.
NOTE: REI Wise offers NAR members a discount on financial analysis and marketing solutions – members can click here to find out more (NAR member login required).
Expressing the benefit of commercial real estate financial analysis, Brendan spelled out CITE — Confidence, Integrity, Trust and Expertise. Learning the basics would give you the confidence to evaluate and analyze properties in your market, to do so with the integrity that comes with your personal knowledge of the market, and will work to build trust in your evaluations as well as build your own expertise as you continue your professional development in commercial real estate.
Fundamentals And Value Indicators
Brendan spelled out that approaching a multifamily property for analysis called for the collecting and description of the Annual Property Operating Data, or APOD. This set of information defines the building’s potential income, subtracts for vacancy, then subtracts for expenses, then subtracts for debt. What’s left is the Net Operating Income, or NOI.. Addressing beginners in the industry wondering what timeframe is used to look at commercial property, Brendan said that valuation is a snapshot of indicators at one moment in time. These indicators, and how to calculate them:
- Price per door/unit = the building price / total number of units
- Price per square foot = building price / total square feet
- GRM (Gross Rent Multiplier) = building price / gross rents
- Cap Rate (Capitalization rate) = Net operating income / building price
- DCR (Debt coverage ratio) = How many NOI dollars come the owner’s way for every dollar of debt the owner took on
- Cash on cash: Yield/ invested dollars