Contact us! Tt is important to understand both your short and long term goals, as well as why you want to buy. Are you starting a business and want to roll in some startup costs to the property purchase? Are you expanding your business? Are you looking for an investment that will provide security and cash flow? Have you identified an area that is growing and you want to speculate on the future value? Are you trying to avoid a tax liability or capital gains taxes? These are only a few things you will want to consider in buying commercial property, and you will want to work on your personal investment strategy with a Solas Associate.

No. Each commercial property is so unique that it is usually best to approach the financing during the due diligence period in the contract. A financing contingency can always be added as well, however, not all lenders “like” to finance every type of deal. Based on the type of property and the financing needs (repairs, improvements, price, risk, property type, timeline, location, etc.), it is typically better to select a lender that best fits your needs after you have a contract in place. Solas has many lenders we can connect you with if you aren’t sure where to start.

When submitting a contract, a buyer will typically put 1% into escrow with the title company to secure the contract as “Earnest Money”.This amount is negotiable, and there is no standard amount, as it only serves as a good faith deposit. This first deposit is applied to the purchase price. If the contract is terminated during the due diligence period, it is typically refunded to the buyer.

At closing, commercial lenders will typically want to see a “down payment” of 15-20% (including the previously deposited “Earnest Money”) of the purchase price. However, depending on the deal, as long as the purchase price is 80% or less of the bank/lenders“appraised value” of the property, the amount of cash needed to close can sometimes be lowered.

NOI is an acronym that stands for Net Operating Income.

According to Investopedia: “Net operating income (NOI) is a calculation used to analyze the profitability of income-generating real estate investments. NOI equals all revenue from the property, minus all reasonably necessary operating expenses. NOI is a before-tax figure, appearing on a property’s income and cash flow statement, that excludes principal and interest payments on loans, capital expenditures, depreciation, and amortization. When this metric is used in other industries, it is referred to as “EBIT”, which stands for “earnings before interest and taxes”.

But what does NOI tell us about a property?

NOI helps buyers, specifically those planning to use the property as an investment, determine the capitalization rate, which, in turn, helps them calculate a property’s value, thus allowing them to compare different properties they may be considering buying or selling. For financed properties, NOI is also used in the Debt Coverage Ratio (DCR), which tells lenders and investors whether a property’s income covers its operating expenses and debt payments. NOI is also used to calculate the net income multiplier, cash return on investment, and total return on investment.

Put simply, Capitalization Rate (“cap rate”) is a percentage formula that compares the ratio of “Net Operating Income” (NOI) to a property’s asset value that serves as a guideline to help understand stability and risk of a property. In general, properties with a lower cap rate percentage are more stable, have less risk, but also have less return (Risk vs. Reward).

CAP rates are calculated using the following formula:

If a property had an NOI of $100,000.00 annually and was being sold for $1,000,000.00 it would have a cap rate percentage of 10% [$100,000.00/$1,000,000.00 = 0.1 (or 10%)].

Let’s take another example: If a stabilized property is for sale at $3,700,000.00 and has an annual NOI of $290,000.00 the CAP rate of 7.8% [$290,000.00/$3,700,000.00 = 0.078 (or 7.8%)].

You may ask “what is a good cap rate?” That depends on how you are using the cap rate. For example, if you are selling a property, then a lower cap rate is good because it means the value of your property will be higher. On the other hand, if you are buying a property, a higher cap rate is good because it means your initial investment will be lower. But what is the real point of this formula and how is it applied? One way to think of cap rate is if you pay all cash for a property, the cap rate would represent your annual rate of return on your investment (how long it will take to make your investment back). However, the most common way to apply cap rates is to quickly size up a potential property purchase relative to other potential investment opportunities. A 5% cap rate acquisition versus a 10% cap rate acquisition for a similar property in a similar location should immediately tell you that one property is likely higher risk than the other. This could be for many reasons, including quality of tenants in place, lease expirations, and deferred maintenance. It will be up to the investor to evaluate how much risk is actually contained in the discrepancy between rates. Another way cap rates can be helpful is when they form a trend. If you’re looking at cap rate trends over the past few years in a particular market or sub-market, the trend can give you an indication of where that market is headed. For instance, if cap rates are compressing (going lower), that means values are being bid up and a market is heating up. Where are values likely to go next year? Looking at historical data on cap rates can quickly give you insight into the direction of valuations.The main thing to consider is how the property compares to similar assets that have sold in the same geographic market location and how it compares to national trends for the asset type. Your Solas associate can help you with acquiring this data and analyzing this value if needed.

Cash on Cash Return is the percentage return of the annual NOI compared to the actual cash you have invested in a property purchase, not including anything that is financed. For example, if you purchase a property for $1,000,000.00, and you make a “down payment” of 20% ($200,000.00), and the Property has an NOI of $80,000.00 (8% CAP rate)your “Cash on Cash Return” would be 25%.