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The COPE framework is just one way to evaluate a commercial real estate investment. Other important metrics underwriters use include operating expenses, vacancy allowance, NOI, cap rates, potential property value, and more. Let’s take a look.
Operating Expenses
Commercial properties have recurring expenses related to owning and maintaining the building year- round. These operating expenses (OpEx) may include property taxes, insurance, and common area maintenance. Typically, the maintenance for office buildings consists of electricity, janitorial, management fees, and other regular maintenance costs.
Vacancy Allowance
Underwriting accounts for the cost of vacancy to forecast future cash flows from any given property. Vacancy rates vary depending on location, market conditions, and asset type.
To calculate the vacancy allowance, you can use this equation:
Annual Vacancy Allowance = Estimated Vacancy % x Building’s Rentable Square Feet x Full Service Rental Rate
| CompStak provides key data to quickly determine Vacancy Allowance. This enables more accurate underwriting and risk assessment. |
Net Operating Income (NOI)
NOI is used to evaluate the profitability of a commercial real estate asset or to determine its value. NOI calculates the actual income a property will produce in a year minus operating expenses.
The NOI also factors in a vacancy allowance and bad debt expense. This gauges what a property’s income will look like under realistic occupancy rates.
| CompStak provides precalculated NOI data on key commercial real estate properties to accelerate the underwriting process. |
Capitalization Rates
The Capitalization Rate (Cap Rate) is the annual percentage return of a commercial real estate asset based on the future income (forward annual NOI) that the investment will generate.
Cap Rate = Forward Annual NOI / Purchase Price
A low cap rate (3% to 6%) means the cost is relatively high. A higher cap rate (7% to 10%) indicates a comparatively more affordable deal.
| CompStak provides predetermined Cap Rates on commercial properties to improve underwriting speed and accuracy. |
Potential Property Value
The most important part of CRE underwriting is calculating the potential property value for a commercial real estate investment.
This calculation takes into account the forecasted annual NOI along with the desired cap rate to derive a final dollar value for the property. This value is considered to be the maximum an investor would be willing to pay for the property.
Property Value = Forward Annual NOI / Cap Rate
| To determine the appropriate cap rate, the underwriter will look at comparable cap rates of recently sold properties in the market. Using an intelligent comps database, such as CompStak, makes this work much easier since the data is easily accessible and already verified. |
Debt Service Coverage Ratio
The Debt Service Coverage Ratio (DSCR) is the ratio of a property’s NOI to its annual mortgage.
DSCR = NOI / Annual Mortgage
This ratio is critical for determining loan amounts. A higher ratio means a lower risk of default, which can translate into larger loan deals.
Net Present Value
Net Present Value (NPV) is used to determine future cash flows of a CRE property by discounting the cash flows to their present value. To calculate NPV, the projected cash flow of the CRE investment is reduced by a discount rate.
NPV combines all future cash flows of a property and provides a value in today’s dollars. This helps determine whether the asset will generate revenue, and if that revenue will be of value after evaluating the time and risk it takes to generate it.
Internal Rate of Return
Internal Rate of Return (IRR) is used to estimate the profitability of a commercial property. If the IRR is higher than the chosen discount rate, this means the property will produce more money than the cost of investment. IRR provides insight into a CRE investment’s return over the entire holding period.
Cost on Return
Cost on Return represents the annual return of the investment as a whole, without accounting for the initial acquisition cost. This metric is used for the purchase of an existing, stable property.
Return on Cost = Annual NOI / Cost of the CRE Investment
Return on Investment
Return on Investment (ROI) measures cash flow that will return to the investor. This is how ROI is calculated:
ROI = [NOI – (Capital Expenses + Debt Service Payments)] / Equity Invested
| With data provided on-demand, CompStak enables you to quickly determine a wide range of factors essential to the underwriting process, such as potential property value, debt service coverage ratio, new present value, internal rate of return, return on investment, cost on return, and more. |
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