Is it the right deal for you? The first step in deciding on a commercial real estate investment property is to compare what it offers to your strategies. Are you focusing on quick cash flow or looking long-term to build wealth? Does the property fit?
One way to see if a property aligns with your strategies is to look at the numbers. When an investor calls a deal “good”, they usually mean the property will generate a strong return. Net operating income (NOI) helps determine cash-on-cash return, yield, and cap rate of a property. It’s the way you know whether a property will make or lose money each year.
NOI is a profitability formula that is calculated by adding up all annual income (property’s gross or potential income), factoring vacancy rate, and subtracting all annual expenses.
After you know the NOI, you can calculate the capitalization (cap rate). This helps you find the rate of return on CRE. A property’s cap rate is calculated by NOI divided by the property’s market value or expected purchase price. NOI does not include mortgage or debt payments to capital reserves, partners, or private lenders.
Some peoples’ brains excel with numbers and others don’t. If you’re the later, connect with professionals to walk you through the property’s NOI and cap rate. In the meantime, here are five things you should know about NOI and cap rates:
1. A property’s gross income includes gross rents, late fees, parking fees, service charges, and additional options like signage, outside storage, etc. Experienced investors know how to maximize a property’s income.
2. Its expenses include vacancy rate, taxes, insurance, management, repairs/maintenance, pest control, utilities, and lawn care. Other costs such as office supplies and legal and accounting services also contribute to the overall cost to “run” the building.
3. A property’s vacancy rate should be provided by the current owner. You need to know how it compares to similar properties of the same type and how the rate affects current and future cash flow.
4. Average cap rates vary according to the type of CRE and the property’s location. An industrial warehouse in a suburb will have a different rate than a downtown office building.
5. A shrewd investor will look at the current and potential cap rate. For example, if the current leases contain below-market rents, the cap rate will change when rents are raised to current market values.
Conclusion
Many factors go into what a “good” cap rate is, including which side of the deal you’re on. When it comes to commercial real estate investment, the right deal for you depends on your investment strategies, goals, and business needs. Knowing the net operating income is one piece you need to consider when deciding to make the jump. I’m here to help if you have any questions.
Jeff Salzbrun is the owner and broker of Commercial Equities Group (CEG). As a veteran-owned real estate brokerage, CEG has been involved in thousands of sale and lease transactions, ranging from single offices to 250,000+ square foot buildings. At CEG, we get your deal done. We know space, and we know the CRE business.
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