Know Your Numbers: Investing in commercial real estate

July 9, 2020

When investing in real estate, you should be familiar with all the numbers associated with the investments. Here we compile all the numbers you will come across when investing in a commercial real estate property:

1. Gross Potential Income (GPI)

Gross potential income is the hypothetical amount an investor would receive without any rental headwinds that are common in the world of real estate. Here, it is assumed that the rental property is rented every day of the year, and the renters will pay the agreed amount documented in the lease. For example, if the agreed rent is $1000 a month, gross potential income is $12000

2. Gross Operating Income (GOI)

Gross Operating Income refers to Gross potential income minus vacancy and credit loss. GOI is not the property’s potential income but represents the actual income the property will generate every year.

GOI = GPI – Vacancy and credit loss

3. Gross Rental Multiplier (GRM)

Gross Rental Multiplier is the ratio of the subject property’s price to its gross rental income. GRM is a property valuation method used by investors to value and compare investment properties.

GRM= Price/GPI

4. Net Operating Income (NOI)

Net Operating Income is calculated by using the total income generated from a property and subtracting the operating expenses. NOI is a before-tax figure appearing on a property’s income and cash flow statement.

NOI = Real Estate Revenue – Operating Expenses

5. Capitalization Rate

The capitalization rate is the rate applied to NOI to determine the present value of a property. This rate is used to determine the value of appreciation or depreciation of property.

Capitalization rate = NOI/current value of the property.

6. Rent/Cost Ratio:

(Is this same as price to rent ratio?)

7. Cash Flow Before Taxes (CFBT)

Cash Flow Before Taxes is the result of calculating the effective rental income, plus other income not affected by vacancy, less total operating expenses, less annual debt service, funded reserves, leasing commissions, and capital additions.

8. Cash Flow After Taxes (CFAT)

Cash Flow After Taxes is the measure of financial performance that looks at the company’s ability to generate cash flow through its operations.

CFAT= Net income + depreciation + amortization + other non-cash charges

9. Debt Service Ratio

Debt Service Ratio is a measurement of the cash flow available to pay current debt obligations. The ratio states net operating income as a multiple of debt obligations due within one year, including interest, principal, sinking-fund, and lease payments.

Debt Service ratio = NOI/Total Debt Service.

10. Break-even Ratio

The Break-even ratio tells you at what level an investment must reach to recover your initial outlay. It is considered a margin of safety measure. It is the sum of all operating expenses and debt service, divide by total potential rental income.

Break-even ratio = (Total Operating Expenses + Total Debt Service)/Potential Rental Income

11. Equity Build-Up Rate

Equity build-up rate is calculated by dividing mortgage principal paid in year 1 by initial cash invested in the property in year 1. This should be calculated because of the principal, although a required part of a mortgage payment, is not considered an expense.

Equity Build-Up Rate = Year 1 Mortgage Principal Paid / Year 1 Initial Cash Invested

12. Price to Rent Ratio

The price-to-rent ratio is the ratio of home prices to annualized rent in a given location. This figure can be used as a benchmark to estimate whether the property is cheaper to rent or own.

price-to-rent ratio = Average home price/average annual rent

13. Cash Flow After Financing

Cash flow after financing shows the net flows of cash that are used to fund the company. The financing activities include transactions involving debt, equity, and dividends.

Cash Flow After Financing = cash inflows from issuing equity – (Cash paid as dividends + Repurchase of debt and equity)

14. Occupancy Rate (Hospitality)

This is the ratio of rented or used space to the total amount of available space in a property.

Occupancy rate = (Total rooms occupied/Total rooms available) x 100

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