Commercial real estate is best valued through metrics. You probably already know that. However, you are most likely unsure of which metrics are the most useful here.

That's precisely what we wanted to cover in today's piece. Let's take a look at some key metrics you need to take a good look at when you're evaluating commercial real estate:

The Capitalization Rate or Cap Rate

Cap rates are one of the most important metrics for commercial real estate. What’s more, it’s almost impossible to evaluate a property without looking at cap rates.

In the most basic of terms, cap rates estimate what the potential return on investment is for a property. The metric does this by using a simple formula: annual net operating income divided by property value or its cost.

Gross Operating Income or GOI

The GOI metric determines the amount of capital you will need to run a property. It does that by taking into account the potential and effective rental income and removing the vacancy and credit losses.

Net Operating Income or NOI

NOI is essentially an expanded GOI metric as it evaluates how much money your property will yield to you once all operating expenses are paid. In more basic terms, NOI is just total income minus total expenses. The income covers rent, monthly fees, and parking, while expenses cover property taxes, vacancy and credit loss, management fees, insurance, maintenance, management expenses, and utilities. 

Only one thing is never included in this metric – the mortgage. That's because a mortgage is always unique to each investor and thus cannot be included here.

The Internal Rate of Return or IRR

The IRR determines how attractive real estate is by defining its profitability. In essence, the higher the IRR, the more profitable the commercial real estate is. 

The metric achieves this valuation by taking into account the initial investment costs, cash flow during the lease period, and discount rates if there are any. This is the basic premise, but if you want more details, take a look at this article. 

Cash-on-Cash Return or CCR

CCR is a useful and relatively common metric used by commercial real estate investors. It determines your cash yield by dividing your annual pre-tax cash with the total cash you invested. 

It’s essentially very beneficial if you’re looking to measure the performance of your investment. However, the metric is not completely accurate as it doesn’t take into account any other investment considerations.

Gross Rent Multiplier or GRM

The GRM is a perfect metric if you want to find the best opportunity in the commercial real estate market. That’s because it takes into account the market value and annual gross income of a property. 

It’s best to use this metric on properties that are relatively close to each other. Also, remember that this is a simple metric, as it doesn’t account for market fluctuations, loan amortization, and operating expenses. 

The Bottom Line

All of these metrics together paint a much clearer picture when you're evaluating a commercial real estate property. For example, if you have a higher gross rent margin then the area, but a lower cap rate, it the property may have higher than normal expenses, which would allow you to possibly make improvements and add value.  However, it’s still vital to understand exactly what each metric accounts for and what it doesn’t. 

The explanations we’ve given you here should prove enough to understand exactly what each metric does. If you want to learn more, you can always reach us at info@cbicommercial.com