Commercial Real Estate
Commercial Real Estate

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Commercial Real Estate
INVESTMENT REAL ESTATE  

INVESTMENT REAL ESTATE

In the world of investment real estate the terms “Cash on Cash” (COC), “Capitalization Rate” (Cap Rate), and “Gross Rent Multiplier” (GRM), are utilized by investors to compare various investment properties in the market place. It is important to remember that the higher the return the higher the risk. Fully understanding the likelihood or risk of achieving each of these measures of investment real estate is crucial to successful commercial real estate investing.

The “Cash on Cash” (COC) return of investment real estate is the net cash flow to the investor after deducting all expenses including debt service.

Example:
Cash Invested: $100,000
Net Cash Flow: $12,000
COC: $12,000/$100,000 = 12%

The cash on cash return and the cap rate will be the same if there is no debt service for an investment property.

Investors can increase or decrease their cash flow on commercial real estate by the type of debt placed on the investment properties. Cash flows can be increased by using interest-only debt, debt with an interest rate less than the cap rate, and by varying the time to pay the debt.

The “Cap Rate” reflects the return on the investment if there is no debt service included in the calculation. Cap rate is calculated by dividing the Net Operating Income (NOI) by the Purchase Price.

Example:
NOI: $100,000
Purchase Price: $1,000,000
Cap Rate: $100,000/$1,000,000=10%

The NOI is the money remaining after all of the “operating expenses” are paid, not including debt service on commercial real estate.

The Gross Rent Multiplier (GRM) is the gross income with no expenses divided by the purchase price. Most frequently GRM is used to compare smaller multi family properties.

Example:
Gross Income: $100,000
Purchase Price: $1,000,000
GRM: $100,000/$1,000,000=10

None of these methods address the quality or the risk associated with investment properties. To determine the risk for commercial real estate the investor needs to consider the credit of the tenant(s), location demographics and the terms of the leases among other things.

It is important to remember that that Cash on Cash, Cap Rate or Gross Rent Multiplier are starting points and handy tools to compare various investments and should not, on their own, be used to determine the risk or suitability of a given investment.


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