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CRE Formulas You Should Know

In commercial real estate underwriting, you need to know the essential formulas to cut through the noise and assess a property’s financial strength and investment potential. Nail these formulas to make sharp, informed decisions and get a real grip on your investments.

Capitalization Rate (Cap Rate)

  • Description: Measures the return on investment by comparing the NOI to the property’s value. A higher cap rate indicates a higher return, while a lower cap rate suggests a lower return.

  • Formula: Cap Rate=Net Operating Income (NOI)Property Value\text{Cap Rate} = \frac{\text{Net Operating Income (NOI)}}{\text{Property Value}}Cap Rate=Property ValueNet Operating Income (NOI)​

  • Visualization of Formula:

Net Operating Income (NOI)

  • Description: Represents the income a property generates after subtracting operating expenses but before debt service and taxes. It is a key indicator of a property’s profitability.

  • Formula: NOI=Gross Rental Income−Operating Expenses\text{NOI} = \text{Gross Rental Income} – \text{Operating Expenses}NOI=Gross Rental Income−Operating Expenses

  • Visualization of Formula:

Gross Rent Multiplier (GRM)

  • Description: A simple valuation metric that compares the property price to the gross rental income. Lower GRMs indicate better investment value.

  • Formula: GRM=Property PriceGross Rental Income\text{GRM} = \frac{\text{Property Price}}{\text{Gross Rental Income}}GRM=Gross Rental IncomeProperty Price​

  • Visualization of Formula:

Return on Investment (ROI)

  • Description: Measures the profitability of an investment relative to its cost. It is expressed as a percentage.

  • Formula: ROI=Net ProfitTotal Investment×100\text{ROI} = \frac{\text{Net Profit}}{\text{Total Investment}} \times 100ROI=Total InvestmentNet Profit​×100

  • Visualization of Formula:

Internal Rate of Return (IRR)

  • Description: The discount rate that makes the net present value (NPV) of all cash flows from an investment equal to zero. It represents the expected annual rate of return on an investment.

  • Formula: IRR is calculated using financial software or iterative methods based on cash flows and investment amounts.\text{IRR} \text{ is calculated using financial software or iterative methods based on cash flows and investment amounts.}IRR is calculated using financial software or iterative methods based on cash flows and investment amounts.

  • Visualization of Formula:

Debt Service Coverage Ratio (DSCR)

  • Description: Assesses a property’s ability to cover its debt obligations with its NOI. A DSCR greater than 1 indicates that the property generates enough income to cover its debt service.

  • Formula: DSCR=Net Operating Income (NOI)Total Debt Service\text{DSCR} = \frac{\text{Net Operating Income (NOI)}}{\text{Total Debt Service}}DSCR=Total Debt ServiceNet Operating Income (NOI)​

  • Visualization of Formula:

Loan-to-Value Ratio (LTV)

  • Description: Measures the ratio of the loan amount to the property’s value. A higher LTV indicates greater leverage and risk.

  • Formula: LTV=Loan AmountProperty Value\text{LTV} = \frac{\text{Loan Amount}}{\text{Property Value}}LTV=Property ValueLoan Amount​

  • Visualization of Formula:

Break-Even Ratio (BER)

  • Description: Indicates the percentage of income needed to cover operating expenses and debt service. A lower BER means a property is more resilient to income fluctuations.

  • Formula: BER=Operating Expenses+Debt ServiceGross Rental Income\text{BER} = \frac{\text{Operating Expenses} + \text{Debt Service}}{\text{Gross Rental Income}}BER=Gross Rental IncomeOperating Expenses+Debt Service​

  • Visualization of Formula:

Cash-on-Cash Return

  • Description: Measures the return on the actual cash invested in a property, expressed as a percentage. It’s a useful metric for evaluating the performance of an investment.

  • Formula: Cash-on-Cash Return=Annual Pre-Tax Cash FlowTotal Cash Invested×100\text{Cash-on-Cash Return} = \frac{\text{Annual Pre-Tax Cash Flow}}{\text{Total Cash Invested}} \times 100Cash-on-Cash Return=Total Cash InvestedAnnual Pre-Tax Cash Flow​×100

  • Visualization of Formula:

Effective Gross Income (EGI)

  • Description: Represents the total income generated from a property after accounting for vacancy and other income sources.

  • Formula: EGI=Gross Rental Income+Other Income−Vacancy Loss\text{EGI} = \text{Gross Rental Income} + \text{Other Income} – \text{Vacancy Loss}EGI=Gross Rental Income+Other Income−Vacancy Loss

  • Visualization of Formula:

Net Present Value (NPV)

  • Description: Calculates the value of an investment by discounting future cash flows to their present value and subtracting the initial investment cost.

  • Formula: NPV=∑Cash Flows(1+Discount Rate)n−Initial Investment\text{NPV} = \sum \frac{\text{Cash Flows}}{(1 + \text{Discount Rate})^n} – \text{Initial Investment}NPV=∑(1+Discount Rate)nCash Flows​−Initial Investment

  • Visualization of Formula:

Gross Operating Income (GOI)

  • Description: Total income generated from a property before deducting operating expenses.

  • Formula: GOI=Gross Rental Income+Other Income\text{GOI} = \text{Gross Rental Income} + \text{Other Income}GOI=Gross Rental Income+Other Income

  • Visualization of Formula:

Operating Expense Ratio (OER)

  • Description: Measures the proportion of income that goes toward operating expenses. A lower OER indicates better cost management.

  • Formula: OER=Operating ExpensesEffective Gross Income (EGI)\text{OER} = \frac{\text{Operating Expenses}}{\text{Effective Gross Income (EGI)}}OER=Effective Gross Income (EGI)Operating Expenses​

  • Visualization of Formula:

Profitability Index (PI)

  • Description: A ratio used to determine the attractiveness of an investment by comparing the present value of future cash flows to the initial investment.

  • Formula: PI=Present Value of Future Cash FlowsInitial Investment\text{PI} = \frac{\text{Present Value of Future Cash Flows}}{\text{Initial Investment}}PI=Initial InvestmentPresent Value of Future Cash Flows

  • Visualization of Formula:

Commercial Real Estate Glossary

Commercial Real Estate Terms You Need to Know

A

Absorption

The rate at which commercial real estate space is leased or sold, indicating market demand and activity.

Absorption Rate

A key metric in commercial real estate that measures how quickly available rental space is being leased over a specific period.

B

Build-to-Suit

Custom commercial real estate development tailored to meet the specific requirements of a tenant, including unique structural and design features.

Brownfield

A type of property that may be contaminated and requires environmental remediation before redevelopment.

Broker

A real estate professional who facilitates transactions, representing buyers, sellers, tenants, or landlords in commercial real estate deals.

C

CapEx (Capital Expenditures)

Major expenses for commercial property improvements or upgrades that enhance the property’s value.

Cap Rate (Capitalization Rate)

A crucial investment metric in commercial real estate, calculated by dividing the Net Operating Income (NOI) by the property’s purchase price, used to estimate investment returns.

Common Area Maintenance (CAM) Fees

Charges incurred by tenants for the upkeep and maintenance of shared areas in commercial properties.

D

Debt Service

The total amount of money required to cover interest and principal payments on a commercial real estate loan.

Due Diligence

Comprehensive research and analysis performed before acquiring or leasing commercial real estate to evaluate the property’s value and condition.

E

Equity

The difference between a commercial property’s market value and the remaining mortgage balance, reflecting the owner’s stake in the property.

Escalation Clause

A lease provision that allows for rent adjustments based on changes in operating costs, such as inflation or increased expenses.

F

Full-Service Lease

A type of commercial lease where the landlord covers all operating expenses, including utilities, taxes, and maintenance.

G

Gross Income

Total revenue generated from a commercial property before deducting any operating expenses.

Gross Leasable Area (GLA)

The total floor area available for lease in a commercial property, encompassing both tenant spaces and shared areas.

Gross Lease

A lease agreement where the landlord pays for all operating expenses, and the tenant only pays a flat rent amount.

H

I

Internal Rate of Return (IRR)

A metric used to assess the profitability of a commercial real estate investment, considering the time value of money.

Investment Property

Commercial real estate purchased with the intention of generating rental income or capital appreciation.

J

K

L

Landlord

The owner of a commercial property who leases or rents it out to tenants.

Landlord Representation

Services provided by a broker who represents property owners in lease negotiations and transactions.

Lease

A legal agreement where a landlord allows a tenant to use commercial property in exchange for rent payments.

Lease Renewal

The process of extending an existing commercial lease agreement for an additional term.

Letter of Intent (LOI)

A preliminary document outlining the key terms and conditions of a lease or purchase agreement before a formal contract is finalized.

M

Market Rent

The prevailing rental rate for commercial properties similar to a given property within the same market area.

Modified Gross Lease

A commercial lease where the tenant pays some operating expenses, with the landlord covering others, often including property taxes and insurance.

N

Net Lease

A lease agreement where the tenant is responsible for paying base rent plus some or all of the property’s operating expenses.

Net Operating Income (NOI)

A key financial metric in commercial real estate, representing the total income generated from a property minus operating expenses, excluding financing costs.

Net Present Value (NPV)

The value of a commercial property investment, calculated by discounting future cash flows to their present value.

NOI (Net Operating Income)

The income generated from a commercial property after operating expenses, used to evaluate property performance.

O

P

Preleased Space

Commercial real estate leased to a tenant before construction or renovation is completed, often in new developments.

Property Management Agreement

A contract outlining the terms and responsibilities for managing a commercial property, including fees and services.

Property Manager (PM)

An individual or company responsible for the day-to-day operations of a commercial property, including maintenance and tenant relations.

Property Valuation

The process of determining a commercial property’s worth based on market conditions, property characteristics, and comparable sales.

Punch List

A final checklist of tasks and repairs required to complete a commercial construction project before it is considered finished.

Q

R

Real Estate Investment Trust (REIT)

A company that invests in income-generating commercial real estate and offers shares to investors, providing a way to invest in real estate without owning properties directly.

Rent Roll

A document detailing all tenants in a commercial property, their lease terms, and rental income.

Rentable Square Feet (RSF)

The total area of a commercial property available for lease, including both usable and common areas.

Return on Investment (ROI)

A performance measure used to evaluate the profitability of a commercial real estate investment, calculated as the ratio of net profit to the initial investment cost.

S

Second Generation Space

Commercial space that has been previously occupied and modified, often including partitions and finishes that may be repurposed for new tenants.

Security Deposit

A sum paid by a tenant to a landlord to cover potential damages or unpaid rent, typically held in escrow.

Shell Space

A commercial property with an unfinished interior, requiring further construction or improvements to meet tenant requirements.

Sublease

A lease arrangement where an existing tenant rents out all or part of their leased commercial space to another party.

T

Tenant

An individual or business entity that rents or leases commercial property from a landlord.

Tenant Improvements (TI)

Custom modifications or enhancements made to a commercial space to suit the tenant’s needs.

Tenant Representation

Services provided by a broker who advocates for tenants during lease negotiations and transactions with property owners.

Triple-Net Lease (NNN)

A lease where the tenant is responsible for paying all operating expenses, including taxes, insurance, and maintenance, in addition to the base rent.

U

Usable Square Feet (USF)

The actual floor space within a commercial property that a tenant can use, excluding common areas.

V

Vacancy Rate

The percentage of commercial rental space that is currently unoccupied compared to the total available space in a market or property.

W

X

Y

Z

Zoning

Regulations and codes governing land use and property development in specific areas, affecting how properties can be used or modified.