Investing in Commercial Real Estate Part 4: Learn the Lingo

Those in commercial real estate have their own vocabulary. It’s also a bit of an exclusive community. One way to convince the players in your area that you’re one of them is to throw around the right terms. If you sound like a single-family home investor, you might not be taken seriously.

These terms also form the basis of your property evaluation. Understanding these terms will allow you to put your numbers to work and compare different investment opportunities.

The terms that every commercial investor should know:

1. Vacancy Rate = number of vacancies / number of units. Ten vacancies in a 500-unit apartment building would result in a vacancy rate of 2%.
   
2. Effective gross Income = gross income – vacancy. Vacancy = vacancy rate x the cost of a vacancy. The cost of a vacancy is the lost rental income.
   
3. Operating Expenses. This is the same as item #2 and includes all the expenses, but not the mortgage. Taxes, insurance, salaries, and so on are part of the operating expenses.
   
4. Net Operating Income or NOI. This is the gross income minus the operating expenses.
5. Debt service is the amount paid over a year on the mortgage.
   
6. Cash Flow. Cash flow = gross income – operating expenses – debt service.
   
7. Capitalization Rate = NOI / sales price. This is one of the most important values to the commercial real estate investor. It’s a measure of the profitability of the property. It’s the amount of income you receive relative to the cost of the investment if you paid cash for the investment. Debt servicing and income taxes are not included in the cap rate.
   
8. Cash-on-Cash Return. This is the annual cash flow divided by the down payment. It’s how much cash you receive relative the amount of cash you have in the deal.

Understand and use these terms when talking to brokers, sellers, and anyone else connected to your deals or the commercial real estate industry. You’ll show that you’re an insider and be taken more seriously. You’ll also grow the confidence needed to have long-term success!

“In any market, in any country, there are developers who make money. So I say all of this doom and gloom, but there will always be people who make money, because people always want homes.”

– Sarah Beeny

Thanks for reading! Stay tuned over the next few weeks for the rest of this series, and as always, give us a holler if you want to chat about your own CRE investing journey.