Essential Commercial Real Estate Terms Shared by Brian Fielding

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Before getting involved in the commercial real estate market, Brian Fielding believes that it is essential investors take the time to learn all that they can about the market. While commercial real estate can be a great investment, it is important that no one goes into the market blind, and the more that each investor knows, the easier it will be for them to be able to make smart decisions about how and when to invest and which properties to choose. To help these new investors, Brian Fielding offers understanding about common industry terms and how they are used.

  1. Cash on Cash: This term refers to the relationship between the return annually on a property and the investment first made on the property. By diving the income on the property each year by the amount of the investment on the property, this number can be determined. This number can be used to compare competing or similar properties to determine their performance.
  2. NOI: Also known as the Net Operating Income, a positive NOI indicates that a property’s annual income is actually profitable. A negative NOI means that the property is losing money. To find the NOI of a property, Brian Fielding shares that the operating costs for a year must be subtracted from the total income on the property for a year. The resulting number will be positive or negative and reveal whether the property is profitable.
  3. Capitalization Rate: This number will show the value of a property and can help determine future profits that the property may produce. Brian Fielding shares that this number can be found by dividing the income of the property by its total value. This method works for properties that are regularly producing an income for the investor.
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Q and A: Capitalization Rates and Property Investment Discussed by Brian Fielding

Dear Mr. F.

Everything that I read about buying and owning commercial real estate references “Cap Rate.” What is “cap rate” and what is its importance to the investor?

 

Dear Dean,

Thanks for writing me and for authoring such a good question. The actual term is capitalization rate but mostly everyone uses the abbreviation. It is a standardized valuation method using the ratio of Net income to selling price. By way of example, consider an investment that is netting [after all expenses] $10,000 and is available for sale at $200,000. A prospective investor would calculate the property by dividing the net return [$20,000] by the sales price [$200,000] and compute that the prospective cap rate is 5%!

Cap rate is a simple tool to measure return and to compare properties against each other. Generally the difference in cap rate between similar properties will be explained by differing inherent risk of the tenancies and the term remaining on the underlying leases.

As an investor, you can use Cap Rate to compare your intended acquisition to others that have occurred in that market. You can also follow trends within that marketplace, perhaps giving you a sense of where investment properties are headed in the future.

A quick warning, however … cap rate is best when used for comparing consistent cash flow and is thus highly emphasized in offerings such as net leased investments and rarely used where rents fluctuate greatly and there is a high risk for tenant turnover.

I hope this helps get you started. Please let us know how your efforts to become financially independent progress.

 

Brian Fielding

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