Learning commercial real estate terms will make investing easier if you are new to commercial real estate investing. Commercial real estate, commonly called CRE, is a property used exclusively for business-related purposes. Or it is used to provide a working space. Here are critical commercial real estate terms that new investors need to know.
Net Operating Income or NOI
Your Net Operating Income is the total operating income minus your total operating expenses. Your NOI summarizes the property’s ability to generate income, regardless of capital structure. The NOI will determine the property’s worth now and in the future. If the NOI increases, your property’s value will also increase.
Return on Investment or ROI
Return on investment is often referred to as cash on cash return. ROI is one of the more essential terms to know because it’s not how much money you spend on the property but how quickly your money is coming out. If you divide your annual cash flow by your down payment, you will get your ROI.
Building Classifications
There are three official classifications of buildings:
- Class A: Buildings that are new or almost new. They are well located, maintained, and feature desirable amenities. These properties have the highest returns.
- Class B: Older buildings don’t offer as many amenities as Class A.
- Class C: These buildings are more than 20 years old. Often they need repairs or improvements.
Knowing your building classifications can help you know the value of a property and not overpay.
Usable Square Footage or USF
This is the amount of square footage that a tenant will occupy in your building. Spaces such as shared lobbies, entrances, hallways, or restrooms are not included in the usable square footage of your structure.
Rentable Square Footage or RSF
The rentable square footage of your property is the usable square footage combined with the shared spaces in a building. Rentable square footage is helpful when deterring what your rent will be for a commercial property.
Debt Service Coverage Ratio or DCR
The debt service coverage ratio is significant for your commercial real estate and financing. You may hear it often from your lenders. DSCR is the amount of cash flow available to pay the mortgage on your commercial real estate property. Your DSCR is calculated by dividing your NOI by your annual debt. Commercial lenders will want you to be able to pay your mortgage and have money left over. The DSCR will tell you how much is left over, which is one reason it is so important.
Variable or Non-Controllable Expenses
These are operating expenses for your property that can change in proportion to building occupancy or with fluctuations in the market. Examples include:
– electricity
– water and oil/gas
– repairs and maintenance
– janitorial and cleaning supplies and service
– property taxes
– snow removal
– insurance premiums
Controllable Expenses
There are operating expenses that do not change based on building occupancy. Examples include:
– security
– landscaping contracts
– painting of common areas
– elevator contracts
– maintenance contracts for HVAC and other mechanical, plumbing, and electrical equipment
– trash removal/recycling
– pest control
There are just a few of the many commercial real estate terms. These are just a few critical commercial real estate terms that new investors need to know but will help build a successful future for real estate investing. If you’re searching for a commercial real estate property, please don’t hesitate to contact us! We’d love to help you find the perfect property for your goals.
