Commercial Real Estate Glossary with Examples
- Commercial Real Estate (CRE): Real estate intended for use by businesses or for the generation of income.
Example: Shopping malls, office buildings, hotels, industrial real estate for sale, self storage units, large multifamily buildings, RV parks, medical buildings. - Sell Commercial Property: The act of transferring ownership of a commercial real estate asset.
Example: A business owner sells their storefront property to a larger retail chain or another local investor. - Sell My Commercial Land: Expressing intent to divest from commercial land.
Example: A landowner advertises, “Prime location for retail development for sale!” Selling your commercial land is generally a good idea if you have no plans to develop the land. - Sell My RV Park: Intent to sell a recreational vehicle park.
Example: The owner of “Sunset RV Park” lists their property for sale as they plan to retire or they have been overwhelmed with management of the property. - Sell My Warehouse: Intent to sell a commercial storage space.
Example: A distribution company outgrows its current space and lists its warehouse on the market. - Selling Apartment Building: Transferring ownership of a multi-unit residential building.
Example: A real estate developer sells a newly completed apartment complex to a property management company. - Land Development: Making improvements to a parcel of land.
Example: A developer buys a vacant lot and transforms it into a commercial plaza with shops and restaurants. - Class A Property: Top tier properties in aesthetics, age, and infrastructure.
Example: A new high-rise office building in a city’s prime business district with state-of-the-art amenities. - Class B Property: Slightly older but still good quality buildings.
Example: A well-maintained office complex built in the 1990s, located a bit farther from the city center. - Class C Property: Older properties in need of maintenance.
Example: A 30-year-old apartment building with few amenities in a suburban area with a high vacancy rate. - Real Estate Due Diligence: Reviewing all facts of a real estate transaction before purchase.
Example: Before buying a hotel, an investor checks its financial records, structural soundness, and any potential legal issues. This is the most important part when selling your commercial property. - Cap Rate (Capitalization Rate): Determine property’s potential ROI (return on investments). This is the most popular formula and is accepted as the first thing you need to know when you are selling your property.
Example: A building purchased for $1,000,000 with an NOI (Net Operating Income) of $70,000 has a cap rate of 7%. - Net Operating Income (NOI): Total revenue minus operating expenses, operating expenses do not include mortgage payments and capital expenditures.
Example: An apartment building generates $200,000 annually in rents but has $50,000 in expenses, resulting in an NOI of $150,000. Depending on what kind of commercial property you are looking to sell, the NOI will be crucial when determining the value of your property. - Vacancy Rate: Percentage of unoccupied units in a property, mostly applicable with office buildings and multifamily buildings.
Example: In a 100-unit apartment complex, if 10 units are unoccupied, the vacancy rate is 10%. Sell with a low vacancy rate, or high vacancy rate to Commercial Real Estate Star. - Liquidity: How quickly a property can be sold without affecting market price.
Example: A popular retail space in a busy city area is more liquid than an isolated warehouse. When you are considering selling your retail strip center or warehouse you need to consider the timeline and how long it will take for the property to sell. - Leverage: Use of borrowed funds to increase potential investment return.
Example: An investor only puts down 20% of a property’s price, borrowing the remaining 80%, amplifying potential returns or losses. When selling your commercial property, buyers will generally have a leverage of 50% to 75% depending on the type of property. You Can sell leveraged property. - Appraisal: Professional assessment of a property’s market value.
Example: Before listing a commercial space, the owner has it appraised and learns it’s worth $500,000. When selling your commercial property you will generally not be required to get an appraisal done. Don’t Worry you can sell without appraisal to Commercial Real Estate Star. - Broker: Person or firm representing buyers or sellers in real estate.
Example: An entrepreneur looking to buy an office space hires a broker to find suitable listings and negotiate deals. You can sell without a broker to Commercial real estate star. - Comparable Sales (Comps): Recently sold properties similar to a property under consideration.
Example: To determine the price of a warehouse, an appraiser looks at recent sales of similar-sized warehouses in the area. Commercial real estate Star can help you run comps on commercial property. - Equity: The difference between a property’s market value and debt currently owed on the commercial property.
Example: If a building is worth $400,000 and the owner owes $250,000 on it, the owner’s equity is $150,000. If your commercial property has a large percentage of equity you should consider selling it and capitalizing on the current real estate market conditions. - Loan-to-Value Ratio (LTV): A lending risk assessment ratio that banks and lenders use when considering lending on a commercial property. This is important to know when you are looking to sell your commercial property and trying to establish a price.
Example: If a buyer is borrowing $320,000 for a property valued at $400,000, the LTV is 80%.
This expanded glossary provides a clearer understanding of commercial real estate terms by contextualizing each definition with a practical example. Always consider consulting with a professional before embarking on a real estate transaction.
Certainly, diving deeper into commercial real estate, there are a plethora of advanced terms and calculations used during due diligence. Here are some of those terms with examples and accompanying formulas:
- Gross Rent Multiplier (GRM): A ratio used to evaluate the relative value of a property based on its gross rental income.
Formula: GRM = Property Price / Gross Annual Rental Income
Example: A property priced at $1,000,000 with a gross annual rental income of $150,000 has a GRM of 1,000,000/150,000 = 6.67. - Cash on Cash Return: Measures the cash income earned on the cash invested in a property.
Formula: Cash on Cash Return = (Annual NOI – Annual Debt Service) / Initial Cash Investment
Example: If NOI is $70,000, annual debt service is $20,000, and the initial investment was $200,000, the cash on cash return is 50,000/200,000 = 25%. - Debt Service Coverage Ratio (DSCR): Determines the property’s ability to cover its mortgage payments from its NOI.
Formula: DSCR = NOI / Annual Debt Service
Example: With an NOI of $80,000 and annual debt service of $60,000, DSCR is 80,000/60,0000 = 1.33. - Breakeven Occupancy Rate: The occupancy rate at which a property neither produces a profit nor incurs a loss.
Formula: Breakeven Occupancy Rate = (Operating Expenses + Debt Service) / Potential Rental Income
Example: If operating expenses are $40,000, debt service is $20,000, and potential rental income is $100,000, the breakeven occupancy rate is 60,000/100,000 = 60%. - Effective Gross Income (EGI): Total income from a property after considering vacancy and credit losses but before deducting operating expenses.
Formula: EGI = Gross Potential Income – Vacancy Losses – Credit Losses
Example: If GPI is $200,000, vacancy losses are $10,000, and credit losses are $5,000, EGI is $185,000. - Operating Expense Ratio (OER): Shows the proportion of a property’s income used to operate the property.
Formula: OER = Operating Expenses / Gross Operating Income
Example: If operating expenses are $50,000 and the gross operating income is $150,000, OER is 50,000/150,0000 = 33.33%. - Internal Rate of Return (IRR): The discount rate at which the net present value (NPV) of future cash flows from an investment is equal to zero. Calculating IRR typically requires specialized software or financial calculators due to its complexity.
Example: An investor wants a 12% return on investment. If the IRR on a property is calculated to be 15%, it exceeds the investor’s desired return. - Amortization: Spreading out the repayment of a loan over a fixed period.
Example: A $500,000 loan with a 30-year amortization schedule means monthly payments are calculated as if the loan will be paid off over 30 years. - Escrow: A financial arrangement where a third party holds funds in safekeeping pending the completion of a contract or agreement.
Example: A buyer might put the purchase deposit into escrow to be held until all sale conditions are met. Commercial real estate star can find an “escrow agent near me.”
Understanding these terms and calculations is essential for anyone looking to delve deep into the nuances of commercial real estate. It provides clarity to both buyers and sellers and aids in making informed decisions.
Operating expenses in a commercial property refer to the costs associated with the operation, maintenance, and management of the property. These expenses do not include capital expenditures or debt service. Here are some examples of common operating expenses in commercial real estate:
- Utilities: This includes electricity, water, gas, sewage, and other utilities essential to the property’s functioning.
- Property Management Fees: Fees paid to a property management company for overseeing and managing the day-to-day operations of a property.
- Property Taxes: Taxes levied by the local government based on the assessed value of the commercial property. You can sell to Commercial real estate star even if you are behind on taxes.
- Insurance: Premiums for insurances such as property insurance, liability insurance, and any other relevant coverage.
- Maintenance and Repairs: Costs associated with regular upkeep, like fixing broken fixtures, painting, plumbing, and HVAC maintenance. It does not include capital improvements which extend the property’s useful life.
- Janitorial and Cleaning Services: Costs associated with cleaning common areas, restrooms, and other spaces within the property.
- Landscaping: Expenses for maintaining outdoor areas, such as mowing, planting, and trimming shrubs or trees.
- Security: Costs for security personnel, surveillance systems, alarms, and other security measures.
- Waste Removal: Fees for garbage collection and disposal.
- Pest Control: Regular inspections and treatments to ensure the property remains pest-free.
- Legal and Accounting Fees: Costs associated with property-related legal matters and accounting services.
- Advertising and Marketing: Expenses to market the property to potential tenants or buyers, which might include brochures, online listings, or signage.
- Common Area Maintenance (CAM): Costs associated with areas used by all tenants, such as lobbies, hallways, parking lots, and shared restrooms. This can overlap with items like janitorial services, landscaping, and utilities in some cases.
- Licenses and Permits: Fees paid to local or state governments for operating the property, which might be recurring.
- Leasing Commissions: Commissions paid to brokers for securing tenants. You can sell real estate without commissions to commercial real estate star.
- Tenant Improvements and Concessions: Allowances or improvements made to customize spaces for specific tenants.
It’s essential for both property owners and potential investors to have a thorough understanding of operating expenses. By closely monitoring and managing these expenses, they can optimize the property’s Net Operating Income (NOI) and, thus, its overall value.
Seller Financing
Seller financing, also known as owner financing, involves the property seller providing a loan to the buyer instead of the buyer obtaining a traditional mortgage from a bank or financial institution. This can be advantageous for both parties, especially when obtaining traditional financing is difficult.
Example: John wants to sell his commercial property valued at $1 million. Sarah wants to buy it but can’t secure a traditional loan. John agrees to a seller financing arrangement. Sarah provides a 20% down payment ($200,000) and agrees to make monthly payments to John for the $800,000 balance over a 15-year term at a 5% interest rate. Here, John acts as the lender, and Sarah sends her monthly payments directly to him.
Creative Financing
Creative financing refers to non-traditional methods of financing a property purchase. It encompasses a variety of techniques that can be used alone or combined, depending on the situation.
- Lease Option: This allows a tenant to lease a property with the option to purchase it later. Typically, a portion of the lease payments is applied toward the purchase price or down payment.
Example: Maria owns a commercial property valued at $500,000. She leases it to Alex for $5,000 per month with an option to buy after 3 years. If Alex decides to buy, a percentage of the accumulated rent (e.g., 25% or $45,000 over three years) goes towards the down payment or purchase price. - Subject-To Financing: Here, the buyer takes “subject-to” the seller’s existing financing. The loan remains in the seller’s name, but the buyer takes control of the property and the payments.
Example: Mike has a commercial property with an outstanding mortgage of $300,000. He can’t keep up with payments. Peter steps in and agrees to take over the mortgage payments without formally assuming the loan. The property title transfers to Peter, but the loan remains in Mike’s name. - Wraparound Mortgage: This involves creating a new mortgage that “wraps around” the existing one. The buyer makes payments based on this larger, wraparound loan amount, while the seller continues to make payments on the original mortgage.
Example: Susan has a commercial property with an outstanding $400,000 mortgage at 4% interest. She sells the property to Bob for $600,000 using a wraparound mortgage at 6%. Bob makes payments to Susan based on a $600,000 loan while Susan continues to pay her original mortgage. - Equity Sharing: In an equity share agreement, two parties—the property occupier and the investor—come together to purchase a property. The occupier lives in or operates out of the property, while both parties share the costs and, eventually, the profits from a sale.
Example: Anna wants to buy a commercial space worth $700,000 but can’t afford it on her own. She teams up with investor Neil. They agree that Anna will operate her business in the space and cover all operating costs, while Neil covers the down payment. When they sell the property, they’ll split the profits based on their agreement. - Land Contract: Also known as a contract for deed, this involves the seller retaining the title until the buyer completes all payments. Once payments are finished, the title transfers to the buyer.
Example: James sells his office building to Karen for $800,000. Karen pays him in monthly installments over 10 years. Only after Karen has made all payments does the property title transfer to her.
Both seller and creative financing can offer flexibility in commercial real estate transactions, opening up opportunities for buyers who might find traditional financing challenging and sellers who might be struggling to sell their properties.
Hard Money Lending
Hard money lending is a short-term, asset-based loan provided by private investors or companies. It’s based on the value of the property, not the borrower’s creditworthiness. Typically, hard money loans have higher interest rates and shorter terms than traditional loans.
Example: Samantha, a commercial real estate developer, discovers a property she wants to renovate and flip quickly. She approaches a hard money lender who agrees to lend her 70% of the property’s after-repair value. Samantha can get the funds more quickly than through traditional lenders, enabling her to snag the property and start renovations immediately.
Seller’s Expectations: Sellers should anticipate that buyers using hard money might close faster, but these buyers might also seek a reduced price due to the higher costs of hard money loans.
Conventional Lending
Conventional loans are the standard loans offered by institutions like banks and credit unions. They are not backed by the government. The terms, interest rates, and requirements can vary widely based on the lender’s policies and the borrower’s creditworthiness.
Example: A company wants to purchase a new commercial space. They approach a bank and get approved for a 15-year fixed-rate mortgage. They undergo a thorough credit check, provide evidence of stable income, and typically need a 20-30% down payment.
Seller’s Expectations: The process can be lengthy due to appraisals, credit checks, and other formalities. While this type of financing is more predictable, sellers should be prepared for potential delays.
Impact of Rising Interest Rates
As interest rates rise, borrowing becomes more expensive. Traditional loans can become harder to obtain, as monthly payments increase and fewer buyers qualify for the amounts they need.
Seller Financing Importance: In a high interest rate environment, seller financing can become a particularly attractive option for buyers. Sellers offering financing can often command higher prices for their properties because they are providing a valuable service to buyers who might struggle with conventional lending avenues.
Benefits for Sellers of Commercial Real Estate:
- Higher Selling Price: By offering seller financing, sellers can often obtain a premium price for their property. Sell for top dollar by selling commercial real estate to commercial real estate star.
- Interest Earnings: Over the term of the loan, the interest paid can significantly increase the total amount the seller earns from the sale.
- Faster Closing Process: Seller-financed deals can bypass much of the bureaucracy inherent in conventional lending, allowing for quicker closings.
- Attractive Investment: In a rising interest rate environment, the note the seller holds might yield a better return than other investment vehicles.
Example: Tom wants to sell his commercial building for $1 million. Jerry is interested but struggles with securing traditional financing due to rising interest rates. Tom offers to finance the sale at a competitive rate. Jerry agrees to a 10% down payment and will pay Tom directly over 20 years. Tom gets a continuous return on his property through interest, and Jerry gets the property without navigating traditional lending red tape.
In essence, when commercial real estate sellers offer financing, they open the door to a broader pool of potential buyers. In situations where traditional lending becomes cumbersome or costly, seller financing can indeed create a win-win for both parties: sellers maximize their profits and buyers achieve their acquisition goals.
When evaluating a commercial real estate property, particularly during the due diligence process, several crucial items need to be considered. Whether you’re looking to sell your commercial property or are on the buying side, being thorough in this evaluation can prevent unforeseen complications and ensure a successful transaction. Here’s a comprehensive list of items to consider:
- Property Valuation: Understand the current market value of the property. This is foundational whether you’re thinking, “I want to sell my commercial property” or considering a purchase.
- Physical Inspection: Ensure a professional inspection is carried out to identify any structural issues, needed repairs, or potential code violations.
- Environmental Assessments: Check for any environmental concerns, like contamination or the presence of hazardous materials.
- Title Search: Examine the property’s title for any liens, encumbrances, or potential disputes. Commercial real estate star pays for the title seach.
- Zoning and Land Use: Confirm the property’s zoning status and any associated restrictions. Ensure the current use aligns with local zoning regulations.
- Leases: Review current tenant leases, including terms, rents, escalation clauses, renewal options, and any other obligations. This is essential if you’re selling commercial real estate with existing tenants.
- Financial Analysis: Examine all financial documents, including profit & loss statements, balance sheets, and rent rolls.
- Utility Bills and Service Contracts: Review utility bills and maintenance contracts to understand ongoing costs and potential contractual obligations.
- Property Taxes: Verify current property tax obligations and check if there are any unpaid dues.
- Operational Costs: Understand the full scope of operating expenses, from management fees to regular maintenance costs.
- Insurance: Check existing insurance policies for coverage limits and potential gaps. Also, investigate if the property has a history of high claims, as this might impact future premiums.
- Tenant Relationships: If you’re thinking, “I need to sell my commercial land or building with tenants,” understand your tenants’ satisfaction levels and whether they’re likely to renew their leases. Commercial real estate star lets you sell with delinquent tenants.
- Market Conditions: Analyze the local commercial real estate market. Look at vacancy rates, average rents, and recent transaction prices to gauge whether it’s a buyer’s or seller’s market.
- Legal Compliance: Ensure the property complies with all local, state, and federal regulations, including the Americans with Disabilities Act (ADA).
- Vendor Contracts: Review contracts with vendors or service providers. Understand the terms and whether they transfer with the property sale.
- Growth Prospects: Consider the growth potential of the area. Is the location up-and-coming, or is it in a decline?
- Parking and Accessibility: Assess the adequacy of parking and how easily clients or customers can access the property.
- Area Amenities: Proximity to public transportation, restaurants, and other amenities can impact a property’s attractiveness.
By being meticulous in evaluating these items during the due diligence process, both buyers and sellers of commercial real estate can avoid pitfalls, ensuring a smoother transaction. For sellers, in particular, understanding these factors can help in setting realistic expectations and potentially optimizing the selling price of the property.
Commercial Real Estate Appraisals
Commercial real estate appraisals provide an objective valuation of a property, facilitating informed decisions for sellers, buyers, lenders, and investors. The valuation is influenced by factors such as location, condition, current market trends, and the income it generates. Appraisers use a combination of methods to arrive at the most accurate assessment.
Here are the primary methods used in commercial real estate appraisals:
- Sales Comparison Approach (or Market Approach):
- Description: This method compares the property in question to similar properties that have recently sold in the same area. Adjustments are made based on differences in size, condition, location, and other attributes.
- Example: If a 10,000 sq. ft. office building in downtown sold for $2 million recently and a similar 8,000 sq. ft. building is being appraised, the appraiser might use the recent sale as a baseline and adjust downwards to account for the size difference.
- Income Capitalization Approach:
- Description: This method is focused on the income a property can generate. The Net Operating Income (NOI) of a property is determined and then capitalized using an appropriate rate to determine the property’s value.
- Example: A commercial building generates an NOI of $100,000 annually. If the capitalization rate (cap rate) in the area for similar properties is 8%, the property’s value is estimated to be $1,250,000 (NOI divided by cap rate).
- Cost Approach:
- Description: This method estimates the land’s value and the cost to replace the existing building with a similar one. Depreciation is then subtracted to get the property’s value. It’s most effective when the property is relatively new or when comparable sales and income data are hard to find.
- Example: A warehouse’s replacement cost is determined to be $500,000. The land is valued at $200,000, and the accrued depreciation on the warehouse is $100,000. The property’s appraisal value would be $600,000 (Land + Building – Depreciation).
- Gross Rent Multiplier (GRM):
- Description: This simpler method divides the property’s price by its potential rental income. While it’s less common for complex commercial appraisals, it’s occasionally used for properties with few units or when detailed income records aren’t available.
- Example: If small retail properties in an area are selling for $500,000 and have potential monthly rents of $5, Commercial Real Estate Star Buys commercial property in the following areas and more
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