Note: By rearranging this formula, you can also calculate a building’s cap rate if the NOI and purchase price are known. This value is generally the maximum an commercial real estate investor would be willing to pay for the property and can change during the negotiation process as variables are altered.įor example, if the underwriter knows the building’s forward annual NOI is $100,000, and also knows that similar buildings in the area have been sold with a cap rate of 5%, the underwriter can calculate that an appropriate price for the building in question is $2,000,000. In order to find the appropriate cap rate to use in this analysis, the underwriter will look at the cap rates of recently sold comparable buildings in the market, similar to how a residential real estate agent might look at recent home sales to determine what their client’s home is worth.Įssentially, if you know what you anticipate the building to produce each year, and you know what cap rate similar buildings are being sold at in your market, you can use these numbers to back in to the property value. Property Value = Forward Annual NOI / Cap Rate
($4 million GPI * 5% Vacancy Allowance = $200,000) Standards will vary depending on market conditions and preference, but an allowance between 5% – 10% is not uncommon.įor example, if our 100,000-RSF building above has a vacancy allowance of 5%, the underwriter will deduct $200,000 from the annual GPI. To account for this, the underwriter will factor in a cost of vacancy to provide a more realistic forecast of future cash flows. While every commercial real estate investor would like their building to be 100% leased at all times, most understand that a vacancy is likely to occur at some point during the CRE investment period. These expenses will be billed back to building tenants through their gross rent or operating expenses. To learn more about what can be included in CAM expenses for each property type, read our article What Are Common Area Maintenance (CAM) Fees?. Typically, what is included in CAM for office buildings is electricity, janitorial, management fees, etc.
These costs are called operating expenses (Op/Ex) and include property taxes, insurance and common area maintenance, or CAM. Just like a residential property, commercial properties have recurring expenses related to owning and maintaining the building that must be paid every year.
Operating expenses, vacancy and more will all be subtracted from GPI during the underwriting process. This number is commonly used by underwriters as the starting point for the analysis.
STABILIZED YIELD ON COST NOI CALCULATION FULL
Gross Potential Income = Building’s Rentable Square Feet x Full Service Rentįor example, a 100,000-RSF building with a full service rate of $40/SF/year has a GPI of $4 million.
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