ACARA™ | Commercial Terms & Definitions

Commercial Terms & Definitions

Cash on Cash Yield (CoC Yield)

Cash on cash yield is a metric used in commercial real estate to evaluate the return on an investment based on the cash invested. It is calculated by dividing the annual pre-tax cash flow by the total cash invested in the property.

Here's a simple Cash on Cash Yield formula:
Cash on Cash Yield = [Annual Pre-Tax Cash Flow / Total Cash Invested] x 100

Where "Annual Pre-Tax Cash Flow" is the net income from the property after operating expenses and debt service but before taxes. "Total Cash Invested" includes the down payment, closing costs, and any additional cash invested in the property.

This metric helps investors understand the return they are getting relative to their initial cash outlay and is useful for comparing different investment opportunities.

Yield on Cost (YoC) / Return on Cost

"Yield on Cost" in commercial real estate development refers to the return on investment based on the total cost of developing a property. It is calculated by dividing the net operating income (NOl) the property is expected to generate by the total development cost.

Here's the formula:
Yield on Cost = [Net Operating Income (NOI) / Total Development Cost] × 100

For example, if a developer projects a property will generate an NOI of $500,000 and the total development cost is $5,000,000, the yield on cost would be:
500,000 / 5,000,000) x 100 = 10% YoC

This metric helps developers assess the profitability of a project relative to its cost. A higher yield on cost indicates a potentially more profitable development relative to its total expense.

Net Operating Income (NOl)

Net Operating Income (NOl) is a key financial metric used in commercial real estate to assess the profitability of a property. It represents the total income generated from a property minus the operating expenses required to maintain it, excluding financing costs and taxes.

Here's a simplified breakdown of the elements needed to calculate NOI:
1. Gross Rental Income: This is the total revenue from renting out the property.
2. Other Income: This can include revenue from sources like parking fees, vending machines, or service charges.
3. Operating Expenses**: These are the costs needed to operate and maintain the property, such as property management fees, utilities, repairs, and property insurance. It does not include mortgage payments, income taxes, or capital expenditures.

The formula for NOl is as follows:
NOI = [Gross Rental Income + Other Income] - Operating Expenses

NOl is important because it helps investors evaluate the potential profitability of a property and compare it to other investment opportunities. It also plays a crucial role in determining the value of a property through capitalization rates.

Cap Rate (Capitalization Rate)

Cap Rate in commercial real estate investment refers to the rate of return based on the income a property is expected to generate relative to its market value or purchase price. It is calculated by dividing the net operating income (NOI) by the property's current market value or acquisition cost.

Here's the formula:
Cap Rate = [Net Operating Income (NOI) / Property Market Value] × 100

For example, if a property generates an NOI of $300,000 and the current market value is $4,000,000, the cap rate would be:
(300,000 / 4,000,000) × 100 = 7.5% Cap Rate

This metric helps investors evaluate the potential return on an investment property. A higher cap rate may indicate a higher potential return but also suggests more associated risk. Conversely, a lower cap rate often implies a lower-risk investment.

Internal Rate of Return (IRR)

Internal Rate of Return (IRR) in commercial real estate investment refers to the annualized rate of return that makes the net present value (NPV) of all cash flows (both incoming and outgoing) from a property equal to zero. It is a metric used to evaluate the profitability of an investment over time.

Here's the formula for calculating IRR: The IRR is found by setting the NPV of future cash flows equal to zero and solving for the discount rate:

0 = (Cash Flow Year 1 / (1 + IRR)^1) + (Cash Flow Year 2 / (1 + IRR)^2) + ... + (Cash Flow Final Year / (1 + IRR)^N) - Initial Investment

For example, if an investor projects a series of cash flows from a property over five years, including an initial investment of $1,000,000 and yearly net cash flows of $200,000, $250,000, $300,000, $350,000, and a final sale price of $1,500,000 in year five, the IRR is the rate at which the present value of these cash flows equals $1,000,000.

IRR helps investors assess the long-term profitability of a real estate project, taking into account the time value of money. A higher IRR indicates a potentially more attractive investment, while a lower IRR may suggest less favorable returns.

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