Commercial Real Estate Analysis Tool
Understanding Commercial Real Estate Metrics
Analyzing a commercial property requires a different set of metrics than residential real estate. Instead of focusing solely on comparable sales, commercial valuation is heavily driven by the income the property generates.
1. Net Operating Income (NOI)
NOI is the bedrock of commercial real estate valuation. It is calculated by taking the Gross Potential Income, subtracting vacancy losses, and then subtracting all operating expenses (taxes, insurance, maintenance, management). Notably, NOI does not include debt service (mortgage payments) or capital expenditures.
2. Capitalization Rate (Cap Rate)
The Cap Rate represents the expected rate of return on a real estate investment property based on the income the property is expected to generate. It is calculated by dividing the NOI by the current market value or purchase price. A higher cap rate usually indicates higher risk and higher potential return.
3. Gross Rent Multiplier (GRM)
The GRM is a quick screening tool used to compare properties. It is the ratio of the price of a real estate investment to its annual gross rental income before expenses. Unlike the Cap Rate, GRM does not account for operating expenses or vacancy.
Practical Example
Imagine you are looking at a retail strip center with the following profile:
- Purchase Price: $2,000,000
- Gross Annual Rent: $240,000
- Vacancy Rate: 10% ($24,000)
- Operating Expenses: $60,000
In this scenario, the Effective Gross Income is $216,000 ($240,000 – $24,000). The Net Operating Income (NOI) is $156,000 ($216,000 – $60,000). The Cap Rate would be 7.8% ($156,000 / $2,000,000), and the GRM would be 8.33.