For those new to commercial real estate (CRE) investing, understanding the terminology is essential. Below is a glossary of some of the most commonly used terms in the industry to help you get started:

Capitalization Rate (Cap Rate)

The capitalization rate, or cap rate, is a key metric that helps investors understand the potential return on a commercial real estate investment if purchased with all cash. The cap rate is calculated by dividing the property’s net operating income (NOI) by its current market price, then expressing the result as a percentage.

For example, if a property generates $100,000 in NOI and is listed for $1 million, the cap rate is 10% ($100,000 ÷ $1,000,000). Essentially, a 10% cap rate means that, if purchased for $1 million in cash, the investor would earn $100,000 in the first year.

Net Operating Income (NOI)

Net Operating Income (NOI) is the income generated from a property after operating expenses are deducted but before accounting for debt, taxes, and depreciation. It is a fundamental metric used to assess the financial health of a property.

To calculate NOI, subtract operating expenses from the property’s gross potential rent. For instance, if a property earns $250,000 in rent and has $150,000 in expenses, the NOI would be $100,000. This figure is important for estimating the property’s market value when applied with a cap rate.

Internal Rate of Return (IRR)

The Internal Rate of Return (IRR) is a metric used to evaluate the profitability of an investment over time. It represents the annual compound rate of return that makes the net present value (NPV) of all future cash flows from the investment equal to zero. Investors often use IRR to compare different investment opportunities and assess long-term returns.

Depreciation

In commercial real estate, depreciation is a method of accounting for the wear and tear or obsolescence of a property over time. Property owners can deduct a portion of the property’s value each year from their taxable income, which reduces their tax burden. Depreciation is typically calculated based on the property’s useful life and is a key tax benefit for real estate investors.

Market Value

Market value refers to the price a property could reasonably sell for in an open market transaction, where both parties are acting in their own interest. It is influenced by factors such as demand, property location, income stability, interest rates, and overall economic conditions. Understanding market value helps investors gauge whether a property is priced fairly relative to its income potential and market conditions.