Four Ways of Earning a Return From Commercial Real Estate Investment
ost new real estate investors do not have any clue as to how the Internal Rate of Return ( IRR ) is calculated. Not only that, many investment property have different ways of earning. Some are easy to manage and others are not. Some got multiple tenants and others do not. Some properties' expenses, like Taxes, Insurance and Maintenance are paid by the tenants and others are not.
I have done a commercial real estate loans for over 15 years. I have seen all kinds of clients. Most come from single family home experience. It is good to have some kind of investment experience but commercial real estate is another animal. Before one invests,I strongly suggest an investor to read or take some of kind of class to determine what kind of asset to invest in.
However, these four ways of generating earning from a commercial property are pretty much the same.
CAP RATE: The net operating income of the property divided by the total purchase price of the property. That means, the yearly money that you will earn from the total cost of the building. For example, you buy a building for $1,000,000 and net operating income of the building is $100,000, that meas you will earn 10% ( $100,000/1,000,000).
CASH ON CASH RETURN: The IRR that you get from the cash you have risked, means the down payment you have put into the game. For example, the purchase price is $1,000,000 and you put $200,000 down and you borrow the $800,000. If the net operating income of the property is $100,000 and you mortgage interest payment expense yearly is $70,000, your earning rate will be 15% ( $30,000 / 200,000 ).
DEPRECIATION: When you depreciate the property and each item of the building according to IRS code, it increases your net operating income. That means your rate of return rises up. However, it increases your Capital Gain as you depreciate the asset to zero. Consult your CPA on this.
APPRECIATION: During time, the value of your property will appreciate by equal or similar to the inflation rate. As renewed rents increase yearly or every five years, your NOI increases and so does the value of your asset. Most assents are value by CAP rate, Net Income over / CAP Rate.
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By George Tesfa