Do you need to better understand the terms used when it comes to commercial real estate investing? Cut through the jargon and learn what everything means.
Average Annual Return
The annual rate of return that one receives on an investment for all of the capital and cash flows invested. It does not factor in the net present value of all monies that go into and out of the investment. The Internal Rate of Return is typically slightly lower than the Average Annual Return because the profits at the end upon sale have a lower net present value than monies that are spent at the beginning of an investment.
Cash on Cash Return
Cash on cash return is a percent of cash out of an investment in a year relative to the amount of cash invested. It does not consider the time value of money. It is a commonly referenced metric; however, it is seldom used professionally.
Commercial is 39 years linear depreciation, residential (to include multifamily) is 27.5 years. This assumes all physical assets will predictably depreciate to a value of zero after this time, and the losses from this offset income on a tax basis. Depreciation is one of the main benefits of investment real estate ownership.
A full-service lease consists of a tenant’s rent that includes all the same components of a Gross Lease, but the landlord is also responsible for paying the utilities used by the tenant.
Gross lease is taxes, insurance, and maintenance which is the responsibility of the landlord. The tenant is still responsible for their utilities.
Internal Rate of Return (IRR)
The annual internal rate of return that one receives on an investment for all of the capital and cash flows based on the net present value for each when deployed. It is the discount rate such that the sum of today’s investment and future cash flows have a net value of zero. It expresses in the form of an interest rate the value of a given investment in today’s terms. It is the most accurate and one of the most widely used ways of calculating and comparing multiple investments by professionals.
NNN or triple net lease is a type of lease in which the tenant is responsible for the taxes, insurance, and maintenance of the building that the tenant leases. Often there is some landlord responsibility (e.g., roof and foundation, parking lot, HVAC, etc.).
NOI (Net Operating Income)
NOI or net operating income is income after vacancy and expenses and before debt service.
Rent ratio is monthly rent / purchase price or market value. Should be 1.0% or more for acceptable cash on cash return with 75-80% loan. Mostly used for rental homes.