Brendan Erickson Of REI Wise: Financial Analysis for Commercial Assets

Like a lot of industries, the commercial real estate business has its own alphabet soup.  It’s laden with acronyms and jargon that practitioners need to communicate, peppering speech, documents and articles with shorthand that can make the business look a lot more complicated than it commonly is.  What’s ironic is the jargon itself is there to make communication easier and faster, even if it has the opposite effect to the newcomer.  You could say that apartment building has a 8% nonleveraged rate of return or you could say it has an 8 cap.  Either way, you’re saying the same, even longer, thing: given a set of key assumptions about tenancy and expense and rents, the net income headed to that building’s owner amounts to eight cents a year for every buck she scraped up, borrowed and handed over to buy it.  

The financial analysis jargon of commercial property valuation is in part about learning, understanding and portraying those key assumptions.  Brendan Erickson, VP of REI Wise (an NAR Commercial Benefits Partner) came to REALTORS® Conference & Expo 2012 to talk about the surprisingly simple principles in valuations lurking in the commercial property alphabet soup.

NOTE: REI Wise offers NAR members a discount on financial analysis and marketing solutions – members can click here to find out more (NAR member login required).

CITE

Expressing the benefit of commercial real estate financial analysis, Brendan spelled out CITE — Confidence, Integrity, Trust and Expertise.  Learning the basics would give you the confidence to evaluate and analyze properties in your market, to do so with the integrity that comes with your personal knowledge of the market, and will work to build trust in your evaluations as well as build your own expertise as you continue your professional development in commercial real estate.

Fundamentals And Value Indicators

Brendan spelled out that approaching a multifamily property for analysis called for the collecting and description of the Annual Property Operating Data, or APOD.  This set of information defines the building’s potential income, subtracts for vacancy, then subtracts for expenses, then subtracts for debt.  What’s left is the Net Operating Income, or NOI..  Addressing beginners in the industry wondering what timeframe is used to look at commercial property, Brendan said that valuation is a snapshot of indicators at one moment in time. These indicators, and how to calculate them:

  • Price per door/unit = the building price / total number of units
  • Price per square foot = building price / total square feet
  • GRM (Gross Rent Multiplier) = building price / gross rents
  • Cap Rate (Capitalization rate) = Net operating income / building price
  • DCR (Debt coverage ratio) = How many NOI dollars come the owner’s way for every dollar of debt the owner took on
  • Cash on cash: Yield/ invested dollars
The math behind these variables is not rocket science.  But putting the variables together in a way that values a property –  or fills gaps in the statements you find in some listings – carries great power and is a bedrock competency for commercial practitioners.
A recording of Brendan’s full presentation “Financial Analysis For Commercial Assets” at REALTORS® Conference & Expo 2012 can be obtained from PlaybackNAR.

 

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14. November 2012 by Wayne Grohl
Categories: Analytics, Conferences, Education, Member Benefits, NAR 2010 Annual Convention | Tags: , , , , , , , , , , , , , | 17 comments

Comments (17)

  1. Pingback: Analysis Idea Blog

  2. Would be nice for all commercial practitioners to be on the same page with the ratios as I’ve seen some claiming ROI for rent/price.

  3. Thank you so much for this information. I am starting to get into more commercial listings and the cap rate information helps a lot in working with some of my investors.

  4. Actually debt service payments are not taken into consideration when calculating net operating income. Cash flow is a term used to show whats left after deducting debt payments from NOI. If you dump the DS under operating expenses, two exactly the same properties which produce the same income and have the same expenses but only one of which is leveraged would produce very different valuations using a cap rate approach.

  5. Being a novice in the commercial market, we found this article very helpful. Thanks

  6. Thanks for the formulas. We have recently begun to list more commercial properties and this information is very helpful. CAP rate information is sometimes hard for us to acquire since we are not actively in the commercial rental business. Any suggestions?

    • Hi Bob,

      Let me say that I’m a researcher, not a broker. I see cap rates heading into a deal as being subjective. You find them published on listings often enough, but I don’t think it’s a good idea to take these as gospel. You do your own underwriting on a property – using area comps for rent or vacancy, let’s say – and you commonly find you get a different cap rate out of that process. At that point, you call up the seller or broker and try to find out why.

      Helping to source comps and helping with the work of generating market proposals where cap rates are of higher quality is the expertise of REI Wise. You can find Brendan Erickson (the presenter of the above) at berickson [at] reiwise.com

      Thanks for reading!

  7. Great Fundamentals to be able to pass on to new investors. They like the basic breakdown in black & white as they are learning the biz.

  8. most buyers have thier own “proprietary” way to value these investments. what we, as professionals, need to be able to supply is ALL of the income expense info. while an apod helps it is often the first place where numbers get “massaged”. the old buyer beware advice is too often apt!

  9. This is MUST KNOW information when working with investors and for agents wanting to learn commercial real estate. Good post and commments!

  10. Thanks for the post. For a newcomer like me it is enlightening to learn these terms & know what they mean.

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  12. Thank you for the excellant and practical information, as I am concentrating once again on the commercial side….

  13. The acronyms are good, but not nearly as important as the formulas themselves or how they are figured out. While I agree it is good to know the verbage, I’m a math guy. Clients are going to be more impressed that I crunched the numbers for them rather than used the terms. Learn the formulas and set yourself apart.

  14. Thank you for the great information…

  15. For any person who wants to learn more about valuing/understanding CRE (commercial real estate) I highly suggest reading some appraisals if you have the opportunity. In reviewing appraisals, you will gain a better understanding of the average CAP rate for the area and how it was determined. There are also websites/services that provide average CAP rates by MSA (metropolitan statistical area).

    Additionally, assumptions for vacancy rates, GRM, and NOI are also included. Do understand that if you are working with a buyer who is obtaining a loan, the bank is going to review the DCR (debt coverage ratio ) to assess the property’s ability to cash flow, the LTV, and the borrower’s ability to support the loan if something happens to the property.

    (I just got into real estate, but worked as a bank examiner reviewing loans made by banks for a long time. :-))

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