# Glossary of Most Commonly Used CRE terms

For new investors exploring commercial real estate investments, it’s helpful to know some of the most commonly used terms and what they mean:

## Capitalization Rate (Cap Rate)

The capitalization rate or “cap rate” provides an indication of the return that a commercial real estate investor can expect in an all-cash purchase and can be used to compare the price of one property to another. The cap rate is calculated as Net Operating Income (see term #2 below) divided by the property’s asking price, and the result is expressed as a percentage. For example, a property with \$100,000 in Net Operating Income and an asking price of \$1 million has a cap rate of (\$100,000 / \$1 Million) 10%. Put another way, if an investor purchased this property with \$1 million in cash and earned \$100,000 in the first year, they would earn a return of 10%.

## Net Operating Income (NOI)

Unlike residential real estate, which is valued on comparable sales, commercial real estate is valued based on the amount of “Net Operating Income” or “NOI” that a property produces.

Net Operating Income is calculated as a property’s Gross Potential Rent; less operating expenses and it is expressed as a dollar figure. For example, if a property produces \$250,000 in Gross Potential Rent and has \$150,000 in operating expenses, the resulting Net Operating Income is \$100,000. To estimate value, a Cap Rate can be applied to NOI. For example, if a 10% Cap Rate is applied to \$100,000 in NOI, the resulting value estimate is (\$100,000 / 10%) \$1,000,000.

## Internal Rate of Return (IRR)

The Internal Rate of Return is another return metric that provides an investor with a property’s annual compound rate of return. Mathematically, it is the discount rate that sets the Net Present Value of all future cash flows equal to zero.

## Depreciation

Depreciation is an accounting concept that allows a commercial property owner to “expense” a portion of the property’s value each year to account for its physical deterioration. This expense is used to offset a property’s rental income and reduce its overall tax liability.

## Market Value

A property’s “Market Value” is the price that it could be bought or sold for on the open market in an arm’s length transaction. In commercial real estate transactions, a property’s market value is impacted by a variety of factors such as: supply & demand, length and stability of the income stream, interest rates, job creation, and location.
Interested in learning more? Get in touch with us today so we can guide you on your next commercial real estate investment.

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CRE Basics

### June 11, 2024

Real Estate Investment Types