hello everyone out there this is Peter have some commercial property advisers also author of this book commercial real estate investing for dummies and coach and mentor to many commercial real estate investors all across this great nation of ours the title and subject of today's video is seven commercial real estate terms you should know I want to start here today and there is a quote from Greek philosopher Aristotle and he says that educating the mind without educating the heart is no education at all I agree with that so in this video I'm going to share with you and teach you seven terms seven commercial real estate terms that are at the heart of every commercial deal that you will run across so do not buy or invest into any commercial real estate deal until you understand these terms okay alright let's jump into the first of seven terms that you must know this first term is called the net operating income also known as the N oh I the Noy is a very important term it is the heart of any commercial deal that you're going to evaluate so it is at the heart of the evaluation of a commercial deal it is a driver of what a property is worth what does the me worth in your future what the cash flow is going to be and also how you're going to make an offer so it's a very important number now let me give you an example how to calculate it before I go into the why okay so here's an example let's say that your rental income is $200,000 okay now this is per year okay rental income at $200,000 per year let's say that you have expenses of $100,000 okay per year okay gross rental income 200,000 and your expenses are hundred thousand dollars per year this is the expenses include property management payroll repairs and maintenance taxes insurance does not include your mortgage pay your mortgage is not in operating expenses of financing expense okay so 200,000 - 100,000 equals you're in a why so you know why is your income minus your expenses okay so here's your noi very important number and how to calculate now you know how to calculate it here's the reason why it's so important as your a2y goes up okay your cash flow not only goes up but your property value goes up and conversely if you're in a wide drops if it decreases your cash flow goes down and your property value goes down okay so that's the correlation that's why you want to make sure that when you buy a commercial property value that your Noi is always going up at least things steady but always going up now here's a technique or strategy that's very powerful that we teach our students it's called the commercial cash out refinance and basically what we're doing here is we are finding locating and evaluating an thusly buying a property where we can increase the rents and increase the Noi and once we do that we have a higher Noi without hiring a white with a higher cash flow higher value we can refinance their property pull out the original down payment or if the investors invest into we will pull out enough money to pay back investors right and then once you have a property where you have no money in what does return on investment it's infinity right so that's the power of their in a Y so the higher the Noi the harder the property value you can refinance and pull all the money up that you put into it again that's the power of the in a Y the second thing is share with you is this age-old formula here that you know from my previous videos and I know the Washington previous videos right so this calculation is called the cap rate is equal to the NY divided by the sales price or here the value okay you know this now what I want to teach you here is we can figure out the value if we know the NY we know the cap rate let me switch this formula up for you and show you the power of this okay pardon my back here okay so value is equal to in a Y divided by the cap rate all right so all I did was I flip this cap rate equation over right so value is now equal to in a Y by the cap rate the reason why this is important is is you need to be able to calculate property values to in order to make an offer or to figure out what a property is worth or what is worth in the future and this is how you do it let's say we use this example let's say I mean where I am here let's say everything here is at 6% cap rate okay in the area I'm buying it's a very common cap rate in this country right 6% so let's say the cap rate is 6% okay and I know the NY right the era is a hundred thousand okay so this formula here the value is equal to in a wine divided by the calf rate the Noy is a hundred thousand the cap rate is 6% so basically my math is 100 thousand divided by 6% do the math it's one point six six million dollars right so you so we have just calculated the property value by the way this is just one of the ways one of the main ways an appraiser will calculate a property value now you know how to do that let's say for example that we bought this property for a million dollars two years ago and we increase the NY from you know eighty thousand two hundred thousand over just raising the rents and doing some renovations right so we bought it for a million we increase Noi two hundred thousand and now is worth one point six million okay so what I have just taught you was how to calculate a property value today and what is worth in your future that's the power of the Noi all right so hopefully you got all this let's move on to the second term everyone must know alright here is the second of seven commercial listing terms that you need to know and it is cash on cash return also known as you return on investment or ROI I'm sure to terminate you've heard somewhere someplace okay cash on cash return is one of my favorite terms right and as I mentioned earlier that the first term was the net operating income the Noy that was the heart of your evaluation the cash on cash is the heart of the money that goes into the investment if you have investor money that's the heart of the investor money if you using your money it's the heart of your money going into the investment now let me show you how to calculate the cash and cash return or their ROI here is the formula here cash or cash is equal to the annual cash flow okay divided by your down payment let me do a quick example for you okay pardon my back again let's say that your annual cash flow is is 12,500 a year and you put down $50,000 okay so the annual cash flow is 12,500 year your your down payment is $50,000 that equals you math here that equals a 25 percent return on investment okay so that means that in four years you are getting your money back okay that's how fast the money is moving in four years okay so you can do four years of 12,500 it will equal your $50,000 injection to the property okay so 25% equals four years now let me share with you why this is such an important term and watch my favorite look at this quote I wrote here thing is not about how much money that goes into the property but it's more about how fast the money comes out of the property okay very important this is known as the velocity of your money again my favorite term let me give you a quick example let's go back to this example here let's say that on this property I'm still putting in $50,000 but my cash flow is twenty-five hundred dollars a year okay but I still put in fifty thousand dollars okay so that gives me a five percent return for some people that may be okay if you play the stock market or paper investments you may be okay with that but in commercial real estate we do nothing that's not a double-digit return some of you may think I'm crazy or far-reaching but it's not the case if one of ideals does not produce at least a 10 percent return or 10% cash a'cash we don't do it plain and simple five percent return means that you're getting your money back in 20 years not too exciting right would you want to wait 20 years to get your investment back three cash flow no you probably not but let me give an example of how fast the money can move here right so let's say this example here where it produces 12,500 year in cash flow let's say for example you went ahead and you raised the rents you did some renovations and you you bumped up the rent and now your cash flow is double this let's say it is now seven 12 five it is $25,000 a year you still put in the $50,000 okay that will give you a 50% it cash on cash return all right that means you're getting your money back in two years okay some of you may think I'm crazy for for even writing on a board is there such things that think of percent cash on cash return but guess what I challenge you to find it very successful Apartments in Decatur out there is very successful right interview him ask him what his cash on cash returns are for the each year or for the life of his investment right and his cash on cash returns this 25 percent this 50 percent or even more are achievable I challenge you to find a good syndicator out there a person who puts together other person's monies and goes out and buys value and opportunities apartment buildings I'm guarantee you you will see Returns like this all right so again this is why the cash the cash return is my favorite term all right so let's move on to the third commercial mistake term that you should know all right here is the third of seven commercial real estate terms that you must know it is called the capitalization rate or for short we call it the cap rate now number two is a cash on cash return which is return on investment that was the heart of the money going into the investment the cap rate is if there could be a term that is the heart of the industry in terms of a singular calculation it will be the capitalization rate or the cap rate the cap rate formula is Noi divided by the sells price it is an industry-wide term okay everyone in commercial uses this term to evaluate a commercial property now in terms of a layman's definition or a easy definition I've come up with this here a cap rate is basically your ROI if you paid all cash to the property so if you pay all cash for the property there's no mortgage what's your return on investment all right so if you have a 1.25 million dollar property and you paid all cash for it but what's your return on your 1.25 million let me give you an example okay so the cap rate is equal to let's say the Noy is $100,000 okay and the purchase price is a million 250 okay so here again the Noy is a hundred thousand dollars divided by the sales price which is 1.25 million okay that's the calculation for the cap rate that is equal to eight percent okay so this 1.25 million dollars that produces a Noi of $100,000 produces an eight percent cap rate got it okay now let me share with you why this is important to know in my previous videos I go way into depth on cap rates in this video in this section I'm going to abbreviate it because I just want to touch over the high-level most important things here's why you must know this term as the cap rate goes up okay so if you find a property where the cap rate is that is high or it's increasing that means that our oh I can go up but what L guess what else goes up your risk goes up because as you go higher in cap rate the neighborhood gets worse and worse and conversely if the cap rate goes goes lower and lower and lower the neighborhood gets better and the risk goes lower and lower and lower that's the probably the most meaningful correlation I can make for you now let me define what's high and what slow in my opinion a high cap rate is a 10 and 11 12 percent cap rate that's a high cap rate to me right so that's a high cap rate a low cap rate for me will be 6 5 & 4 I will consider a low cap rate so in those high cap rate areas you're going to have the challenging neighborhoods in the low cap rate will be the neighborhood's you probably would live in okay all right so that's the correlation there now another important reason that you must know this term is I don't want you to be full it says here don't be fooled don't be full with what Peter right don't be fooled with deals that advertises high cap rate deals meaning eleven twelve fourteen percent cap rate all right those deals for example if you see them advertised they're advertised for reasons no one else bought them but other that if it's a high cap rate deal be careful there's probably something majorly wrong with the deal so don't be fooled because most times a high cap rate deal isn't a very challenging evident maybe even a bad neighborhood and there's a quote here I'm going to share from you from a very successful person who bought a lot of bad properties in neighborhoods and you know some we're ghosts are bad here's this quote you can't manage your way out of a bad neighborhood that is so true it's not that your management's bad is not that you know your strategies of that is the culture of the neighborhood that prohibits you from managing successfully all right so again don't be fooled if you find a high cap rate property twelve thirteen fourteen percent put the brakes on examine it very harshly get a mentor get someone who's very experienced on making sure that that this investment will work and as safe as it can be all right okay let's move on to number four welcome to number four of seven commercial real estate terms you should know number four is debt coverage ratio also known as DCR for short what I mean by debt here is your mortgage payments on the property or we about to put in the property if your mortgage payments are a thousand dollars a month then a debt here is one thousand times 12 months which is twelve thousand okay so annual debt here now when you think about commercial you think about financing at the heart of it all is the DCR debt coverage ratio let me explain the debt coverage ratio if I could give you a simple explanation it would be the amount of cash flow left over after paying the mortgage got it or it would be how well does your net operating income how long is your Noy cover the mortgage right here's the formula then the DC r is equal to the noi divided by your annual debt service now let me do the calculation for you so you can see let's say that you're in a why is one hundred one hundred thousand dollars I'll keep it consistent for us and your annual debt service is eighty thousand dollars so again you're in oh why is one hundred thousand dollars a year your annual mortgage payments are $80,000 you do the math here right it comes out to be one point two five that's a multiple that means that your Noy covers your mortgage payments by one point two five times very important number now why is that important well again in the world of commercialization financing your lender your lender is going to look at DCR as the first check they're going to do this calculation when they decide to say this is a deal they want to do or not they will like your minimum to be one point two zero if you drop below one point two zero your lender is going to ask you to put down a larger down payment and that can affect your return on investment right so this is why this is a very important term you need to know now a good target this is my guideline a good target would be to produce a deal that has a debt coverage ratio minimum of one point four to one point five in my opinion that's a really strong deal all right so 1.4 1.5 an upper very strong deal you get great finance the last thing I want to share is let me give you a correlation on depth coverage ratio and how it pertains to your deal and how I can make it better as your DCR goes up alright so as this number increases guess what happens it's potentially possible that your down payment can go because I just never it gets higher and you're able to cover the mortgage better that means your cash flow goes up that means the lender is willing to give you more loan dollars making your down payment go down all right so that's the correlation here now that is debt coverage ratio again it's a very important number if you really want to understand or begin to understand the correlation and what send up the heart of commercial real estate and financing it's DCI alright so let's go to number five here we are number five of seven really important commercial real estate terms that you must know number five is price per unit or price per square foot what is that I will share that in a moment but these two terms are at the heart of determining what a property is worth and what you should make an offer on all right so the worth and offer price is at the heart of these two terms now how do you determine price per unit and pressure square foot let me start here these two terms pertain to your sub market or to your neighborhood in different neighborhoods you will have a different price per unit as well as a different price per square foot all right so these two terms will be different in respective neighborhoods so I want you to be an expert in your neighborhood because prices are different in different neighborhoods got it okay let's continue to figure out a price per unit here's the formula here price divided by the number of units $500,000 purchase price divided by ten units equals fifty thousand dollars a unit sometimes fifty thousand dollars unit can be referred referred to as fifty thousand dollars per door okay and for a retail commercial building or an office building we can use this the price per square foot okay so the price is 500,000 the square footage is 10,000 square feet so 500,000 divided by 10,000 is $50 per square foot all right got it so now you know how to determine price per unit and priceless per square foot it's really important because remember they only pertain to your sub market to your neighborhood got it okay here's why it's important if you know the price per unit in your sub market it will help you gauge your offer price if you recall earlier I discuss with you how to determine a property value or a sales price by using the income method if you recall the formula was value or sell price is equal to Noi divided by the cap rate recall that a few months ago well that was the first way that an appraiser would use in determining the value of a commercial property this is the second way this is known as the sales method or comparable sales method the first one was the income at that this is the comparable sales method where you would gather three comparable properties and you average out the price per unit and you would compare to yours so if your average came out to be $50,000 per unit you don't want to offer more than $50,000 per unit because the other properties have sold for this so knowing the price per unit price of square foot will help you make sure you don't overpay okay that's the importance of knowing these two numbers in your sub market next here's a question to ask yourself it is the asking price realistic so what the broker or sellers is asking for to sell the property to you is it realistic you wouldn't know if it were if it was realistic or not if you knew these two numbers in your son market okay hopefully that's starting to sink in now lastly if you are a commercial wholesaler wheaty saturn uh company basically we break it down to three steps number one is find a good deal number two get under contract and number three find a buyer and flip it to the buyer so this commercial wholesaling 101 so if you are a commercial wholesaler by knowing the price per unit of a project square foot in your sub market you know if you have a good deal or not that's a very very valuable skill to have to position yourself to make a lot of money when you commercial wholesale the property so again price per unit and price per square foot in your sub market is at the heart of determining what a property is worth and what your offer price will be so let's move on to number six all right number six of seven commercial real estate terms that you must know that you should know number six is building classification how do we classify commercial buildings well we we put them in it in a box and that box is called in a box a B box and the C box actually call those classes so we have an A Class building a B Class building and the C Class building now let's see what each one is about and we also discover why you need to be able to put these different buildings in different boxes because they mean different things to different types of investors number one an a-class building is the newest building around brand news beautiful or shiny it's in the best location alright and a highest rent all of you have seen as you driven downtown the downtown beautiful apartment buildings with commercial no bottom highest rents and various beautiful buildings right so those are considered a class buildings now a notch down from the a-class is the B Class alright so it's an ex-nurse down is older but it's still good you have working-class people in there it's not a bad building but it's not as beautiful as this building okay it's kind of an average looking building what quote unquote average tenants okay now below the b-class we have the C class building C Class buildings near the oldest buildings you have the lowest rents most times the building needs upgrades and inside the buildings you have maybe lower to middle-income tenants so that's how we determine a Class B Class and C Class now there is also a D as in dog a D class that's a class that's a really not officially class but that's a a property where it's probably mostly vacant or nearly all vacant getting tougher neighborhoods we do not mess with those properties all right so as a beginner don't go there now here's why we need to really understand why we fit a certain building in a certain classification number one if we look at an a-class building they're not for you let's look at an a-class office building it is sitting downtown it is beautiful it's a skyscraper is probably 50 to 100 million dollars of value it is where I live and it's not for you and the reason why is these institutional buyers these funds from here and overseas those are the buyers so they're okay with a 5% return with 2% return and they pay a 50% down payment and they're okay with lower terms they just want the asset so that building is not for you if especially if your beginning investor so we tend to leave the a-class alone for those type of buyers the B Class is where we want to begin to play the B Class or the most stable properties there for you all right now here's a goal with the B Class the goal for you is to find a B Class property in an a neighborhood all right so if you can find a B Class property in a neighborhood fix it up so you can get a class your rent you have a winter got it so go look for a B Class property fix it up into a neighborhood raise rents and you'll make a lot of money next is C Class C Class 4 apartments imagine C Class Apartments where you have lower to middle income people there will always always be a demand for this type of apartment building in our country always alright in fact these days because of the prices compared to the B and C these are probably the most profitable today because of the high prices of A's and B's sedated into the demand for them but imagine AC class apartment with D servants you cannot afford to build brand new c-class Apartments you can because their rents are too low and the building cost is too high so C Class is the way to go if you're looking for a cash flow and if you're looking for the highest potential for cash flow but there's a warning here be careful if you approach C class the C class can have a lot of rehab a lot of renovation and it could be a challenging neighborhood with challenging tenants you need skill you know mentor you need an advisor to buy C Class properties and C class neighborhoods all right so now hopefully you know how to place a property into the a box the beat box and the C box and now you understand why they're in those boxes alright so let's go to number seven which is the seventh and final commercial estate term you must know okay here we are number seven of seven commercial real estate terms that you must know number seven is you must know the type of leases that you have in the building and the reason why is imagine you're buying this big property that's cash line what gives you the right to collect the income on the property right you're in a cash flow business what gives you the right to take your tenant to court they don't pay right if you have if you have a legal instrument or at least you have no right to collect you're out of business that's the purpose and the importance of a lease so basically a lease is a written agreement between the landlord and tenant it's a legally binding agreement now in an apartment building we have leases right and by the way all of our leases are approved and written by our attorneys and for an apartment building a Leakes could be a month-to-month lease it could be a 12-month lease or it could be a nine-month lease either/or and they're all goodness they all serve their purpose for something like an office building or retail center we have different types of leases here we have a full-service lease we have a triple net lease and then modified grosses let me briefly explains to you I go in detail on other videos previous videos and on all these three different leases but just for the sake of brevity a full-service lease means that their landlord pays for everything insurance taxes repairs utilities all that he pays for the tenant just pays them a flat fee the triple net lease is the opposite where the tenant pays for everything right and a lot of Lori thanks for nothing other than his mortgage so if you're looking for something super super passive this is the way to go right triple net lease a modified gross lease is in-between your full service and triple net lease so the tenant and the landlord they split certain expenses that's what a modified gross lease is now let me share with you why it's important so important to understand leases for the at releases you're going to get yourself involved in when you buy a commercial property now I'm going to use this description here imagine we have a human heart okay and huge heart we have a left artery and we have a right artery and imagine human hearts through the left arguing the right artery 2,000 gallons of blood flow through every day every day imagine one or both these arteries get clogged or stop working or just fall away you will cease to exist you will write because there's no blood flowing through your body now imagine that you're building your commercial building is your heart and you have a left artery and you have a right artery okay and these arteries is left in right artery where everything flows through where your blood is now money if the money stops then this building will cease to exist foreclosure right so this artery here and this arguing here are your leases that's how important your leases are okay they're like the arteries to your heart now let me finish with this I took a very long and lengthy and difficult class on leasing commercial property it's very complex a lot of legal terms and let me give you the bottom line here's the truth the professor told me Peter imagined that you're buying a million-dollar property and what you're doing is to look at the importance of the leases what you're doing is you're buying the leases for $1,000,000 and the building comes for free got it that's how important it is so the building leases are worth a million dollars and the building is worth nothing without the leases all right that's how important leases are so that's why you must understand and read every single lease that you get all right so that's the important that's why I left that there is very important there the last all right I told you this was the last term but I'm going to give you a bonus term that's probably more important than all of these terms together if you want to be a successful commercial estate investor and have long lasting success you all right here we are the eighth and probably the most important term this eighth term gives meaning to the previous seven this a term makes it all work together and causes you to be successful three questions here real quick what gets you the best deals in the industry I'm going to give you the answer in a second what will convince a seller of a commercial property to work with you instead of others and lastly why would a commercial estate broker send you his or her off market deals or their pocket listings why would they do that well let me tell you this the answer is not money right money would not get you the best deals money will not convince a seller to work with you only and surely money will not have a broker send you all of his best deals money is not the answer here's the answer hold on one second okay here's the answer commercial real estate is a relationship based business yes the answer is relationships you must be able to nurture and develop relationships in the industry okay relationships will get you the best deals they will cause a seller to work with you only and they will cause a broker to send you his or her best deals this is a relationship based business so I want you to get good at developing and nurturing relationships in this industry what sellers were brokers with lenders with property managers all above you must have relationships with all of them to be successful and be long-lasting in this business okay so that's probably the best term of all to make your previous seven work together in harmony all right okay so if you want more videos like this please go to our website commercial property advisors calm or simply subscribe to this YouTube channel thank you all for watching this latest video on 7 a.m. real estate terms you must know I will see you at the next video
