Commercial Real Estate Dictionary

Cash on cash is calculated as CFBT (cash flow before taxes) / (the initial investment). This is your best indication of the quality of the investment. It accounts for NOI, debt service, and depreciation.

Credit-tenant property

A single-tenant commercial property occupied by a tenant who has a credit rating by Moody's or Standard & Poor of BBB or better.

DCR (Debt Coverage Ratio)

DCR is what your banker will want to know before lending you money for the investment. It is calculated as

(NOI) / (debt service) , where "debt service" is defined as the annualized payment of the loan or loans on a property

Generally speaking, a banker will want to see DCR of at least 1.1 or 1.2.

Discount Rate

The rate at which future cash flows are discounted (devalued) per year

Gross Operating Income

Also called the Gross Scheduled Income, this is the property's annual income if all spaces were rented and all of the rent actually collected, minus an allowance for vacancy and credit loss.

IRR (Internal Rate of Return)

This is calculated by setting NPV = 0, and finding out what the discount rate would be. It is an iterative (guessing) calculation. Don't try to do this manually - use Excel or a calculator.

NOI (Net Operating Income)

NOI is calculated as (Gross Operating Income) - (Operating Expenses). This should always be a positive number. If it is not, the property is not an investment, it is purely speculation - that is, you would be buying it in the hope that it will increase in value. I cannot caution you strongly enough that commercial property should always bought and sold on the metrics of cash flow - to do otherwise is extremely risky.

NPV (Net Present Value)

This is a method for calculating the present value of future cash flows. it is a valuable method for comparing different investments and their returns. Simply described, each future cash flow is discounted for each year further out that it arrives, and the sum of these discounted cash flows is NPV. Formulaically:

NPV = - (initial investment) + CF1 + CF2 + CF3 +... (1+K) (1+K)2 (1+K)3

Fortunately, you don't need to manually calculate this. Microsoft Excel has a built-in NPV function, and many financial calculators also provide NPV calculations.

Operating Expenses

Defined as utilities, supplies, snow removal and property management, repairs and maintenance, and property tax. Improvements and additions are not "opex" - they are capital expenditures. Your mortgage interest may be a deductible expense, but it is not an operating expense. Loan payments, depreciation and capital expenditures are not considered operating expenses.

Optimum Holding Period

The number of years to hold a period in order to maximize ROE - after this period, it is best to sell or exchange the property.

ROE (Return on Equity)

This is calculated as CFBT / equity. It is an important measure which will tell you in later years of ownership if it is time to cash out (or hopefully exchange - see the 1031 exchange pages) the equity for a new investment. As your equity grows from appreciation and mortgage retirement, this ratio generally grows smaller, meaning your equity is not working as hard as it can for you (see "Optimum Holding Period" above.)