What are the best financial performance metrics for commercial properties?

1. Cap Rate: Reflects return potential and property value based on income. 2. Cash on Cash Return: Measures annual income over the cash invested. 3. Net Operating Income (NOI): Indicates profitability after operating expenses. 4. Internal Rate of Return (IRR): Assesses overall project profitability over time. 5. Debt Service Coverage Ratio (DSCR): Shows ability to cover debt payments. 6. Gross Rent Multiplier (GRM): Compares property price to gross rental income. 7. Occupancy Rate: Percentage of rented space, indicating demand. 8. Loan-to-Value (LTV) Ratio: Assesses risk by comparing loan amount to property value. 9. Operating Expense Ratio (OER): Portion of income spent on operating expenses.

NOI is extremely simple to understand. revenue - op expenses. It's the same formula a lemonade stand uses. Nearly all of the complicated activates we engage in are trying to make this number bigger by increasing revenue and decreasing expenses. This is the cornerstone for much of CRE, which values properties based off how much income it generates compared to the price.

NOI is simple to understand. Take your total rental income and reduce 30% for expenses. This number can be different depending on the situation. For example, if the property is NNN, than the expenses might be lower.

NOI is the basis for determining the value of an asset, and growing NOI is the name of the game for investors and operators alike. A simple formula of revenue less operating expenses, this is the metric considered when talking about a value-add opportunity. There are only 2 levers to pull, grow revenue (lease-up, rate increases, expansion, ancillary income streams) or reduce expenses (automation, payroll reduction, management efficiencies). The best operators do both.

Put simply, Cap rate is just how much a marketplace values a source of cash flow. The lower the cap rate, the more someone is willing to pay for the income source. The high the cap rate, the less someone is willing to pay for the income source. In practice, it's used a measure of risk and profitability. If something has higher capitalization, there's a reason: it's likely older, poorly positioned, or risky in some other way. The reason why it's helpful is because you can compare properties against one another, even if they're not exact like-kind, because they've been flattened to "how much will I pay for this stream of income?"

Cap rates are set by the market and used to determine the value of an asset based on its NOI. They are simultaneously incredibly simple and overly complex. The easiest way to understand what cap rate means is to say it is (slightly less than due to costs/fees/etc.) equal to the current unlevered cash on cash return of a CRE investment, or what your annual cashflow will be after expenses if you purchase a property in cash. The issue with cap rates is that the calculation is based on NOI, which is driven by expenses. One buyer to the next may underwrite a very different operating expense structure, and each of those may differ greatly from the seller's in place expenses. This means a 5% cap rate can yield different values for all involved.

Cash on Cash return is, simply put, how much money you can expect to put back in your pocket each year from an investment. Distributable cashflow is what's left after all expenses have been paid, including debt service. If you invest $100k and $5k is returned to you in cash each year, your CoC is 5%. This is a useful metric in comparing opportunities, and is certainly an important one for investors to focus on when prioritizing an annual income stream. Often times, higher CoC numbers in the early years or throughout the life of an investment come at the cost of lower total back end returns, or total ROI.

Here's a simple back of the napkin calculation that a mentor of mine taught me: When underwriting a CRE property, assume the OER is 40-50% of the revenue. This might not be true, but if the numbers are WAY off even then, it's likely not worth underwriting in more depth. Saved me a lot of time.

As a borrower of commercial real estate, please be aware that permanent financing lenders (such as agency lenders, CMBS, etc.) will underwrite the DSCR INCLUDING amortization even if the loan has several years of interest only built in.

Although we have several financial ways of analyzing commercial investment, we should use the ones that make it easier for the clients to grasp. We also should know that the clients views are not necessarily those of the lenders, matter of fact it’s likely different!

They are missing the best one. Stabilized yield on cost. Here's an excerpt from a recent post of mine: "Yield on cost is a forward-looking metric, measuring what the property will be worth after the operator makes improvements and stabilizes the NOI. In other words, YoC is a future cap rate that bakes in an investor's business plan assumptions."

Remember, these metrics may vary depending on the specific commercial property and market conditions. It's important to conduct thorough research and analysis before making any investment decisions.

A preliminary forecast can a Comparable Market Analysis. This is a informal unlicensed appraisal. Real estate agents can help with this. Few this to consider: - Location, Year built and size - Sales price, Dollar adjustments and fair market value - Special fixtures outside fireplace, club house, guest w, ect. - Is the area prone to natural disasters or vandalism? - Is there any nearby park developments, walking trails, ect ?