Most real estate investors start off investing in single family homes which is a comfort everyone is familiar with since we all live in a home and not a commercial property. With a residential home investment your return on investment diminishes when bought at a higher price because the rental income (your return) is too low to justify the price. Here is Phoenix the the cut off is approximately $200,000. Also, if your tenant moves out then you are stuck with a few months of paying the mortgage before you locate a new tenant.
With a commercial property investment your return on investment is higher because you have multiple units rented that justifies the price paid. Also, since you have multiple units a tenant moving out will not effect you financing because the other units are still generating income to pay the mortgage.
A lot of investors shy away from commercial investments simply because they don’t understand the terminology and how to properly analysis a property to know if it’s a good investment or not. The follow are some terms a beginning commercial investor should understand:
1) Rate of Return = The percentage return on each dollar invested. Also known as yield. Calculated by taking cash investment divided by total purchase price.
2) Net Operating Income = The rental income minus total expense.
3) Annual Debt Service = Expense of a mortgage including principal and interest.
4) Initial Investment = The sales price plus acquisition costs less the amount of the mortgage loan is the down payment.
5) Cash Flow Before Taxes (CFBT) = The net operating income (NOI) less the annual debt service equals cash flow before taxes.
6) Equity = The value of one’s interest in the property consisting of fair market value less any outstanding debt or other encumbrances.
7) Cash-on-Cash Return = Calculated as cash flow before taxes (CFBT) divided by the initial investment or down payment.
8) Cap Rate = The cap rate is basically the return on investment from the property without considering financing. It’s the net operating income divided by the purchase price.
These are basic terms any investor should understand before purchasing a commercial property. The professionals at Position Realty can help you with determining which properties offer the best return on investment. We have development proprietary spreadsheets used to successfully analysis commercial investment opportunities.
If you are thinking about purchasing a commercial investment property give us a call since we will give you honest and accurate feedback regarding which property to buy. We specialize in helping small to medium size investors reach their investment goals.