It’s critical to understand a few key investment property terms when considering purchasing a commercial property. Knowing what a “value add” is and what “cap rate” means will help you determine whether a property is worth the investment and how much money you can expect to earn after you choose which type of investment property to purchase.
Here are Two Important Investment Property Terms Explained
What Does “Value Add” Mean?
Value Add requires an investor to identify an operational or physical issue that if corrected, will increase the value. A few examples of a Value Add Property, could be a landlord that does not respond timely to tenants, deferred maintenance that is a constant eyesore to existing or new tenants, an owner that lacks funding to make improvements, a property that is dated and requires modernization, or a property that is short on parking, all which make it difficult to lease or keep a property leased 100%. Thus, properties of this nature typically have a higher vacancy rate in the marketplace and can be more valuable with proper management, upgrades, or additional services, which equates to low vacancy, greater rental income, and a higher value when completed.
What Does “Cap Rate” Mean?
A Cap Rate is determined when dividing the Net Operating Income (NOI) by the property value. The NOI is the net revenue to a landlord that a property provides after expenses are paid, such as real estate taxes, property insurance, and maintenance. Credit tenants who sign long-term leases with the tenant being responsible for all property costs, (RE Taxes, Insurance, Maintenance) have less risk and therefore a lower cap rate. Noncredit tenants who sign shorter term leases and have fewer property responsibilities for maintenance, or paying for taxes or insurance have a higher risk and thus a higher cap rate. A warehouse leased to a national tenant in a large city downtown area near an international airport and various interstate highways would be considered low risk or a low cap rate. The higher the cap rate the higher the return to a buyer, but also the higher the risk that could be caused by a shorter lease term, an inferior location, the tenant’s credit, or the condition of the property.
Looking for a broker to walk you through more investment terms? At Ullian Realty, located in Melbourne, FL we utilize the Ullian Process to help you determine the best commercial property for your investment goals. With over 50 years of combined experience, our team of brokers is ready to help today. Give us a call to learn more.