As a real estate investor, it is crucial that your understand all of the important commercial real estate definitions and terms. We have listed some of the most common and fundamental commercial real estate definitions as a quick reference below:
The absorption rate represents the rate in which units are leased in a specific real estate market or area. Absorption is calculated by dividing the average number of units per month by the total number of units available. For example, we figure out that 1000 units has been leased in a 12 month period. We take the 1000 units divide 12 months then lastly divide the rate into the number of active units to get the absorption rate of your market area. If a apartment building had 10,000 square feet of new leases in 2017 and 2,000 square feet of tenants leaving, its positive net absorption is simply 8,000 square feet. The absorption can be calculated for a singular building or by an entire market.
The interest on a loan that accumulates during the loan period and paid at the end of the loan term.
Capitalization Rate (Cap Rate)
The capitalization rate is the percentage of your funds that paid for the project that comes back to your annually. For example, if you purchase a commercial real estate property for $500,000 that return $50,000 annually, your cap rate is simply 10%. The standard calculation for Cap rate is NOI / Price.
Cashflow is the net amount of cash and cash-equivalents moving through the commercial investment property.
A cash-on-cash return is the percentage of monies invested in a building that is returned to an investor annually of financing payments have been made. The cash on cash return is usually higher than the capitalization rate, with favorable terms.
Contract rent is the dollar amount of the rental obligation that was specified in the lease, also referred to as face rent. Contact rent is determined by the square footage in a commercial real estate property.
Debt service coverage ratio (DSCR)
The DSCR is a measurement of cash flow available to pay current debt obligations. The ration is the net operating income in a multiple of debt obligation due within one year; includes interest, principal, sinking-fund and lease payments.
The rate used to determine how much the money will cost to borrow over time.
Interest only Period
An interest only period is when the borrower is only making interest payments to the investors or loan for a set period of time. At the end of one of these periods, the borrower is usually required to satisfy the loan principle with a balloon payment, re-amortize the loan, or the property has been sold.
Market rent is the accepted price to lease a space for residential or commercial purposed. For example if a 1,500 square foot apartment is listed for rent for $3,000, it is because similar spaces in the local market are also leasing at this price. Investors use market rent to discover opportunities in local markets to increase rents and profits.
Mixed Uses Development
Mixed uses development is the use of a building or several building for more than a singular purpose. An example of this type of commercial real estate development would be a condo building with a Starbucks and a bagel shop at the base of the condo building.
Multifamily Real Estate
Multi-family residential real estate is a classification of housing where multiple, separate housing units for residential inhabitants are all contained within a single or several building within one complex. Commonly referred to as an apartment building.
Net Operating Income (NOI)
The net operating income or NOI is the measurement used to analyze real estate investment that generate income. NOI equals all revenue from an investment property minus operating expenses. NOI normally appears on the investment property’s income and cash flow statements. When the NOI is negative, it is usually referred to as the net operating loss (NOL). NOI helps real estate investors compare different investment properties they may want to buy or sell.
Offering Memorandum (OM)
An offering memorandum is a legal document that states that objectives, risks, and the terms of the real estate investment to the investors. The OM serves as a guide to provide the buyers or investors with information on the real estate offering and to protect the seller from the liability of selling unregistered securities.
The occupancy rate refers to the percentage of occupied units in a commercial real estate property. The occupancy can be determined in building or in the market.
A preferred equity stock is a type of ownership that has higher claim on its assets and earning than common stock. Preferred equity generally have a dividend that must be paid out to investors be for any common shareholders including the owner of the asset.
The preferred return or “pref” is a confusing term in regards to real estate investing. It is commonly described as the claim on the profits given to an investor on an investment opportunity. Usually when the profit percentage is reached, the excess profit is split among all of the investors as agreed. This is the most common type of return used in real estate investments.
Private Placement Memorandum (PPM)
A private placement memorandum or PPM is a ledge document provided to investors to sell stock in relationship to a real estate business. The PPM describes the company selling the security, terms of offering, and the risk of the investment.
A pro forma is a method that is used to calculate financial results. The pro forma places significant emphasis on present or projected figures.
The rent roll is a document that provides a snapshot of the current income representing the owner’s asset. The rental income derives from an income producing real estate asset.
Trailing 12(t-12) or Profits and Lost
A real estate investment’s trailing 12 represents its financial performance for a 12 month period, but not the fiscal year. The t12 is calculated by adding together all four quarters. The T12 helps determine the overall value of a multifamily asset and the income it brings.
The vacancy rate refers to the percentage of unoccupied units in a commercial real estate property. Similarly to occupancy, vacancy can also be determined by the building or the entire market.
So there you have a short list of the most important commercial real estate definitions and terms. I hope these terms will help you in evaluating any commercial real estate investment, especially within the multifamily residential real estate. If you have additional terms you would like us to add, feel free to reach out to us at [email protected]. or you can check out investopedia for more real estate investment terms and examples.
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