In commercial real estate, the floor plate is the amount of leasable square footage on an individual floor of a building. In multistory buildings, especially taller office properties in major urban areas, the floor plate on lower floors is likely to be larger than the the floor plate on higher floors. In some cases, a building's floor plate is also known as its footprint.
A waterfall and promote structure, also known as a waterfall model, is a method for distributing the profits from a real estate investment in an uneven way. Typically, the project's sponsor (the individual or group putting most of the work in to identify, acquire, and manage the property) will receive a disproportionate share of the profits, known as a promote, as long as the project hits certain profitability benchmarks.
In hotel construction and acquisition, price per key is a metric that compares the amount of money spent on building or aquiring the hotel with the amount of rooms, or keys, in the hotel. To determine price per key, simply use the formula below:
Total Hotel Construction or Acquisition Cost/Total Number of Rooms (Keys) = Price Per Key
What is a Break-Even Ratio in Commercial Real Estate?
The break-even ratio for a property is the percentage of its gross operating income that the property needs to break even, i.e. for costs to equal expenses. Investors can use a property's break-even ratio to determine if it's a good investment; too high of a break-even ratio may be a red flag. Break-even ratio can be calculated using the formula below:
Debt Service + Operating Expenses/Gross Operating Income = Break-even Ratio
For example, if a property had an annual debt service of $40,000, annual operating expenses of $35,000, and a gross operating income of $100,000, we would calculate the break-even ratio like so:
$40,000 + $35,000/$100,000 = 0.75 or 75% Break-even Ratio
How Lenders Use Break-Even Ratio In the Loan Approval Process
It's not just investors who use a property's break-even ratio; in addition to looking at a property's LTV and DSCR, lenders also use this metric in order to determine the risk of a potential loan. In most cases, lenders prefer a break-even ratio of 85% or less in order to provide a reasonable financial cushion for the borrower should expenses increase or the property's occupancy rate fall unexpectedly. An 85% break-even ratio means that expenses can increase another 15% (or operating revenue can fall 15%), and the property will still be able to break even.
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RevPar, or revenue per available room, is a measure of a hotel's financial performance, which can be calculated by dividing a hotel's total room revenue by the amount of available rooms. Another easy way to calculate RevPar is to multiply a hotel property's ADR (average daily rate) by its occupancy rate.
An anchor tenant is the largest or most prominent store in a retail commercial real estate development, intended to help draw customers into the area. In strip centers and power centers, anchor tenants are often big-box stores or grocery stores, while in shopping malls, they're more likely to be department stores.
A power center is an outdoor shopping center with multiple big-box retailers, as well as an array of smaller retailers, restaurants, and other kinds of businesses. Power centers are typically located in suburban areas due to cost and space restrictions, but can sometimes be located in urban areas as well. Many power centers are set up as large strip centers, but also may contain several out-parcels, pieces of land intended for individual tenants, such as banks or fast-food chains.
In industrial real estate, a property's clear height is the height to which product can safely be stored on racking. Clear height can also be defined as the height of a building from the floor to the bottom of the lowest hanging item on the ceiling (i.e. sprinklers, lights, etc.). In recent years, clear height has become much more important due to the increase in online retailers, many of whom are trying to increase warehouse efficiency in any way possible.
Restrictive covenants are restrictions placed on the use of a property. In commercial real estate, restrictive covenants may be placed on a property by a lender, restricting the activity of the owner while a loan is being repaid, or, by an owner, restricting the activity of tenants. In addition, restrictive covenants can also be written into a property's deed, either for a certain number of years or indefinitely.
An operating expense ratio, or OER, sometimes simply known as an expense ratio, is a metric comparing a property's operating expenses to the amount of income it generates. To determine a property's operating expense ratio, you can use the formula below:
Operating Expenses/Gross Operating Income = Operating Expense Ratio
For example, a building with operating expenses of $40,000 a year that brings in $100,000 of gross income would have a 40% OER.
Amortization is the process of spreading a loan into payments that consist of both principal and interest over a set timeline, called an amortization schedule. While many commercial real estate loans are fully amortizing, not all are. For example, balloon loans are typically only partially amortizing, while interest-only loans usually have a non-amortizing interest only period, then a period that is either partially or fully amortizing.
An interest-only loan is a type of loan in which the borrower only needs to pay the interest, not the principal, for a specific amount of time. This period will typically be laid out in the loan agreement. After the interest-only period of the loan ends, the loan will become a typical, amortizing loan, in which the borrower contributes to both the interest and the principal of the loan with each payment.
What is an Prepayment Penalty in Commercial Real Estate?
In commercial real estate loans, a prepayment penalty is a fee charged to borrower if they attempt to repay their loan early. When a lender issues a loan, they typically want to lock in their profit for a certain amount of time, so the prepayment penalty is a way to compensate them for their financial loss if the loan is paid off early.
Lock outs in Commercial Real Estate
While most types of commercial real estate loans have prepayment penalties, many also have lock out periods-- a specific period of time in which a borrower cannot repay the loan, no matter what. Therefore, borrowers should be very careful when looking at commercial real estate loans with long lock out periods, as these may make it very difficult to sell the property before the lock out period is over.
Step Downs vs. Soft Step Downs
After the lock out period (if there is one), a borrower can often pay off their loan for a certain percentage of the loan amount. If the percentage declines year by year, for example, 6% in the first year, 5% in the second year, 4% in the third year, and so on, it's called a step down prepayment penalty. In comparison, some loans have what's called a soft step down prepayment penalty. Soft step down penalties usually start lower and decline more slowly. For example, instead of the 6-5-4-3-2-1 step down in the example above, a loan might have a 4-3-3-2-2-1 soft step down penalty.
USing Defeasance to Pay off A Loan Early
Some commercial real estate loan types, such as CMBS loans and certain kinds of life company loans may be much more difficult to get out, since there is external pressure on the lender to provide a certain rate of return. For CMBS loans, the CMBS bondholders expect a certain, guaranteed return, and life insurance companies need to know they can pay policy beneficiaries the promised amounts on their life insurance policies. If a borrower wants to get out of one of these loans, they will usually have to engage in a process called defeasance, in which they will purchase government-backed securities, such as treasury bonds, in order to repay the loan and guarantee the lender a specific rate of return.
Assumable Loans And Prepayment Penalties
As previously mentioned, prepayment penalties on commercial real estate loans can be a big hassle if the borrower wishes to sell the property with a few years after purchasing it. That's why borrowers may wish to check if a loan is assumable before making a final decision. An assumable loan can be transferred to a new buyer (with the lender's approval) typically for a small fee. A commercial property with an assumable loan may actually be easier to market, since the new owner may not have to go through as many hoops as they would to take out an entirely new commercial real estate loan.
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In commercial real estate, an assumable loan is a loan that can be taken over by a buyer when the owner of the property sells. Determining whether or not a loan is assumable (and under what conditions it can be assumed by a new buyer) can be very important, since otherwise, an owner/investor could face significant prepayment penalties if they need to pay off the loan in order to sell the property.
Discounted Cash Flow Analysis, or DCF analysis, is a method used to determine the current value of a set of cash flows using a predetermined discount rate. In practice, DCF analysis is often used to compare the potential return from a commercial real estate investment to the estimated return from another investment, such as a stock, mutual fund, private equity investment, or another piece of commercial real estate.
A load factor, also known as a loss factor, is a metric that compares the amount of space a tenant has to pay for in a commercial lease, versus the amount of space they can actually use. The load factor or a commercial lease can be calculated with the formula below:
Rentable Square Feet/Usable Square Feet = Load Factor
Load factor is important because tenants in commercial leases, especially leases for office buildings or large retail developments like malls, typically have to pay for their percentage of a building's common areas.
If you're a commercial real estate investor deciding whether a property is a good fit for your portfolio, you might have heard of the 1% or the 2% rule. The 1% rule states that a property's monthly rent must be at least 1% of its purchase price in order for the owner to break even. The 2% rule states that a property's monthly rent needs to be at least 2% of its purchase price in order for the owner to make a sustainable profit.
Occupancy rate is one of the most important metric for temporary housing, which includes multifamily properties like apartment buildings, as well as hospitality properties, like hotels, motels, and resorts. Occupancy rate can be measured by dividing the number of occupied nights by the number of available nights.