As with any sector or industry, the world of financing and commercial real estate has its own terminology. It can take some time to get up to speed on what these terms mean and how they affect a commercial real estate investor. But if you're serious about entering into this area of business, you need a firm understanding of real estate and investment terminology. Here is a brief explanation of some of the most common commercial real estate terms.
Net Operating Income
Net Operating Income, or NOI, is generally calculated as the profit a commercial property generates after certain expenses have been paid for. NOI is reliably calculated after the first year of operation for a building.
Also known as the "cap rate," this is the net operating income of a property divided by the price of the property. It gives you a starting, simple number on which to base the profit potential of a property. Higher cap rates are usually associated with higher risk.
Building classification works similarly to a school's letter grading system and refers to the overall usefulness, value, or appeal of a property. A building classification of 'A' means the structure is new, likely located in a desirable area, and probably built with high-quality materials in construction. A class 'B' building would be less expensive, less desirably located, and probably comprised of lower quality materials.
Debt-Service Coverage Ratio
Debt-Service Coverage Ratio, or DSCR, is calculated by taking your NOI and dividing it by your total debt service. It tells a lender just how much money you will have left over after paying your debts. A DSCR of 1.2 generally means you're a safe risk, as you'll have the money—and then some—to cover your debts every month.
Rentable Square Footage
Rentable square footage refers to the number used to determine the amount of space in a building that is actually available to rent to tenants. This number will be critical in figuring just how much you have to rent, and, ultimately, how much you will charge for that rent in order to collect your income.
Some investment properties are simply large buildings, while others are actually several buildings grouped together. For an example of how investors are able to secure a loan for this type of property, see our Ohio success story page.
But certain lenders are also willing to work with commercial properties that are smaller in size. Even with less rentable square footage, the property may generate enough income to be a strong investment opportunity.
It's always important to do as much homework as you can and be educated about your terms and your options so you can make an informed decision. Then, when you're ready, reach out and apply with our commercial mortgage experts for your loan solution.
You can also visit our Loan Terms page to increase your familiarity with common commercial mortgage terminology.