Understanding Commercial Real Estate Terminology
Understanding the language is critical when navigating the world of commercial real estate. Whether you are an investor, a business owner, or a real estate professional, knowing the industry’s key terms will help you make informed decisions and communicate successfully.
What is Net Operating Income?
Net operating income (NOI) is a formula used to evaluate the profitability of real estate investments that generate income. Apart from rental income, a property can generate additional revenue through amenities such as parking structures, vending machines, and laundry facilities.
NOI = Real Estate Revenue – Operating Expenses
Operating expenses encompass the expenditures associated with the operation and upkeep of the building, including insurance premiums, legal fees, utilities, property taxes, repair costs, and janitorial fees. However, capital expenditures, such as the expenses for a new air-conditioning system covering the entire building, are not factored into the calculation.
What is Amortization?
Amortization refers to the process of dividing a loan into periodic payments that include both the principal amount and the interest. As each payment is made, a portion goes towards reducing the outstanding loan balance (principal), while another covers the interest the lender charges. This allocation is done according to a predetermined timeline known as an amortization schedule. Amortization schedules outline the payment amounts and breakdowns for each installment, allowing borrowers to track their progress in repaying the loan.
It’s important to note that while some CRE loans follow a complete amortization structure, not all loans adhere to this approach.
What is a Triple Net Lease?
A triple net lease, often abbreviated as NNN lease, is a lease agreement where the tenant is responsible for paying the base rent and most or all of the property’s operating expenses. These expenses typically include property taxes, insurance premiums, and maintenance costs.
Under a triple net lease, the tenant assumes a significant portion of the financial responsibilities associated with the property beyond just the rent. This type of lease structure is commonly used for commercial properties such as retail buildings, office spaces, and industrial facilities.
What is Cash-on-Cash Return?
A cash-on-cash return is a commonly utilized rate of return in CRE deals, which evaluates the cash income generated in relation to the cash invested in a property. The cash-on-cash return is calculated by dividing the property’s pre-tax cash flow by the total cash invested, including the down payment and any additional costs associated with the property acquisition.
Cash-on-Cash Return = Annual Pre-Tax Cash Flow / Total Cash Invested
This metric provides investors with a clear understanding of the cash return they are receiving on their invested capital. It helps evaluate the efficiency of the investment and allows for comparisons between different properties or investment opportunities.
What is a Commercial Real Estate Sale Leaseback?
A sale leaseback is a financing tool utilized by business owners in various industries. The process occurs when an owner sells their property and signs a lease with the buyer, who then obtains the property. The previous owner then begins paying rent to the buyer.
The use of a sale leaseback has become a crucial tactic for releasing hidden value and positioning a company for future expansion. This widely used financing tool enables owner-operators to release their locked-up cash and put it to better use. This capital return is fantastic for reinvesting in the company, funding expansion and additional locations, or even paying off debt.
What is the Annual Percentage Rate?
The annual percentage rate (APR) refers to the true annual cost of borrowing funds for a loan. It is the yearly rate charged for borrowing money and considers the total cost of the loan over a predetermined period. The APR includes both the interest rate and any additional fees or charges associated with the loan, allowing borrowers to understand the actual cost of financing over the loan’s term.
In CRE, lenders may charge various fees, such as origination, application, appraisal, and closing costs. These costs are included in the APR calculation, along with the interest rate. By considering the APR, borrowers can better understand the loan’s overall cost and compare different financing options more effectively.
What is a Debt Yield?
Debt yield serves as an assessment tool for commercial mortgage lenders to evaluate the risk associated with a loan. Considering the NOI generated by a commercial property determines the speed at which the lender could recover their investment if the borrower defaults. Certain lenders favor this metric as it provides a clearer picture of loan risk compared to other methods that might be influenced by low-interest rates or extended amortization periods.
Debt Yield = NOI / Loan Amount
