COMMON KEY TERMS IN COMMERCIAL REAL ESTATE

Updated: Feb 13




1031 Exchange


A 1031 Exchange is a process where you can defer your capital gains taxes by using the proceeds from the first investment and reinvesting them in another investment within a certain time frame. Learn more about it HERE.

Active Investor


An Active Investor is a party involved in the day to day activities that are involved in owning real estate. An active investor finds properties, hires and maintains communication with the sales team, and continuously monitors the profitability of the investment. The active investor is opposite to the passive investor.

CAP Rate


The cap rate is a shortened term for Capitalization Rate. The cap rate is used to calculate the rate of return that is expected from an investment property. To calculate cap rate, take your net operating income (NOI) and divide by the market value of the property,

CAP rate = NOI / Market Value (MV) of the property.


Check out this ultra-simplified example:


Rent = $1,200

Expenses = $200

Market Value of property = $10,000


The 2 parts of the formula we need are NOI and MV of property. The MV is given, so we need to calculate NOI. To calculate NOI, we take Rent-Expenses. So,


$1,200 - $200 = $1,000


Now that we have NOI and MV, we can calculate the cap rate. So,


$1,000 / $10,000 = 10%


This 10% means that we can expect a 10% return on the first year of our investment.

CapEx


Capital Expenditures are commonly known as CapEx. CapEx are expenses that are for the improvement of the property. CapEx are not regular, frequent expenses (that would be operating expenses!). Some examples of CapEx in commercial real estate investments are roof repairs, irrigation systems, or parking lots.

Capital


Capital is term for financial assets. Capital can include cash or funds that have been obtained through financing sources such as family, friends, or financial institutions.

CF


A very common CRE term is CF, which stands for Cash Flow. Cash Flow is the take home amount an investor makes after all of the expenses and loan payments are paid for. The more expenses you have, the less Cash Flow you will have in your pocket at the end of the month. The less expenses you have, the more money you can keep in your pocket.

CRE


One of our most common acronyms used: CRE. CRE stands for Commercial Real Estate. To be classified as commercial real estate, the building has to be used to create cash flow for the owner. Under the CRE umbrella, the most common sectors you can find are Multifamily, Retail, or Industrial. An apartment complex must have 5 or more units to be considered a commercial property. If you buy 4 units or less (ex: duplex or triplex), you are operating in the residential real estate realm.

EGI


EGI stands for Effective Gross Income. The EGI goes hand in hand with PGI (Potential Gross Income). The difference is, EGI is the income earned after taking into consideration vacancies.


An example:


Assume you have 30 units at $1,000/unit, so you have a PGI of $30,000.


However, there are 5 units that are vacant (at $1,000/unit), which has a loss of income of $5,000.


So the EGI is found by calculating PGI – vacancies, which would be $30,000 - $5,000 = $25,000.

IRR


IRR stands for Internal Rate of Return. The IRR is an annual rate of return that an investment is expected to generate. It is ideal for analyzing an investment to determine your expected returns over a period of time.

Lease, Lessor, and Lessee


When a tenant moves into a property, there is a lease signed and two parties become involved, the lessor and lessee. The lease is a contract where the landlord gives the tenant the right to occupy the space for a certain amount of time for a specified price. The individual that rents the out the property becomes the lessor, aka the landlord. The individual who the property is rented to becomes the lessee, aka the tenant.

LTV


LTV is short for Loan-to-Value. The LTV is a ratio used by lenders to show the mortgage loan amount to the total value of the property. To calculate the ratio, you take the total amount of your loan and divide by the value of the property

LTV = ( Loan Amount / Property Value ).


For example, you have loan that is for $300,000.


The total value of the property is $500,000.


So to find LTV, ($300,000 / $500,000) you get an LTV of 60%.

Market Price


The Market Price is what the buyer is willing to pay for a property and what the seller is willing to accept for the property. In other words, it is the price exchanged for the property. The transaction that takes place determines the market price, which will then influence the market value of future sales.

Market Rent


The Market Rent is the rent that the owner would charge the tenant to rent the property. It is the market value of the base rent based on other comparables of similar units and within a close proximity.

Market Value


The Market Value is an opinion of value for what the property would sell for, given its features and benefits. In other words, it is what the property is worth.

MF


MF is an acronym for Multi-Family. MF is a category of real estate which is suitable for multiple families to live in 1 building. It can consist of 2+ units in a building. Some examples can include duplex, triplex, or apartment buildings. If a building has 2-4 units, it is classified as residential, whereas 5+ is classified as commercial property.

NOI


NOI stands for Net Operating Income. To calculate NOI, you take the total amount received for rent from all tenants and then deduct your expenses,


NOI = Revenue - Total Expenses


The common expenses that will get deducted are things like utilities and repairs/maintenance. The NOI is what you would expect to make before paying your mortgage and for capital improvement expenditures.

Operating Expenses


Operating Expenses are common, more frequent expenses that it would cost to run and maintain the property. Some examples include maintenance, small repairs, utilities, payroll, property taxes, and insurance.

Passive Investor


A Passive Investor is a party that stays “behind the scenes”. They only help with the financial aspects of the investment are not actively involved in the day to day activities. The passive investor is opposite from active investor.

PGI


PGI stands for Potential Gross Income. PGI is the income you may potentially earn, given that you have full occupancy.


Let’s look at an example:


Assume you have 30 units in your apartment complex.


The rent is $1,000/ unit.


So, 30 units x $1,000 = a PGI of $30,000 / month.

Price per Unit


The Price per Unit is a common term used when purchasing a property. It is referred to the price you pay for each unit in the building.


Check out this example:


Assume there are 50 units in the building. The total cost for the building is $500,000.


To find the price per unit, you divide the total building cost by the number of units.


($500,000 / 50 = $10,000)


We find that each unit has a price of $10,000.

Property Management Fee


A property management fee is a common recurring fee that is paid to have a property management company maintain the common day-to-day operations of owning the property. Some responsibilities of the management company include directly communicating with potential tenants, handling maintenance and repairs, and responding to tenant inquiries. Property managers generally charge a percentage of the total rental income and the ranges are between 8 - 12%.

ROI


ROI stands for Return on Investment. ROI is a ratio used to determine your gains for that project compared to the amount of money that you put in, expressed in percentage form. To find ROI, you take your gains and subtract your investment cost and divide that sum by your investment costs.


ROI = (Gains – Investment Costs) / Investment costs

Syndication


A syndication is a partnership between multiple investors that combine their skills, resources, and capital to invest in large properties or projects that they would not be able to acquire on their own. Read more about syndications HERE.


Phew! You made it through the whole article, congrats!!! Hope you learned a few things, and don't forget to pay it forward. Share it with someone who you think would benefit from reading this article.



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