COMMERCIAL REAL ESTATE INVESTMENT FUNDAMENTALS
NOI is also used to calculate the value of a property. The value is often expressed through the Capitalization Rate (Cap Rate). The Cap Rate expresses the relationship between NOI and value (price). The relationship between NOI and Cap Rate is an inverse correlation; that is, the higher the Cap Rate, the lowe rthe value ofthe property. The lower the Cap Rate, the higher the value ofthe property.
Cap Rate = NOI/ Value (Price)
• A property with $50,000 of NOI that is valued at $625,000 has an 8% Cap Rate.
(50,000/625,000 = 0.08)
• A property with $75,000 of NOI and a 7.5% Cap Rate would have a value of $1,000,000.
(75,000/0.075 = $1,000,000)
Net Operating Income (NOI) is a key figure it is what is left after collecting rents and paying expenses. From NOI, the owner needs to pay for debt service (the mortgage), income taxes, their own business operating expenses, and hopefully make a profit and return on their investment.
The basic elements of an investment are cash inflows, outflows, timing of cash flows, and risk. Your ability ability to analyze analyze these elements elements is key in providing providing services services to investors investors in commercial real estate. CRE investors are just like other investors in that they are primarily concerned with the return on and return of their investment. It is a more objective measure of a successful real estate transaction and requires specific types of analysis.
Cash inflows and outflows are the money that is put into, or received from, the property including the original purchase cost and sale revenue overthe entire life ofthe investment.
Cash inflows include the following:
• Operating Expense Recoveries
• Fees: Parking, Vending, Services, etc.
• Proceeds from Sale
• Tax Benefits
• Tax Credits (e.g., historical)
Cash outflows include:
• Initial Investment (down payment)
• All Operating Expenses and Taxes
• Debt Service (mortgage payment)
•Capital Capital Expenses Expenses and Tenant Leasing Leasing Costs
• Costs upon Sale
The timing of cash inflows and outflows is important to know in order to project periods of positive and negative cash flows.
Risk is dependent onmarket conditions, current tenants, and the likelihood that they will renew their leases year-over-year. You need to be able to predict the probability that the cash inflows and outflowswill be in the amounts predicted, what is the probability that the timing ofthem will be as predicted, and what the probability is that there may be unexpected cash flows, and in what amounts they might occur.
There are some very sophisticated software packages to assist you with this analysis, or you can do this with simple spreadsheets. But this is the type of analysis that is required when working with CRE investors.
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