EXCLUSIVE INVESTOR NEWSLETTER

Real Estate Investment Primer

Newsletter Volume 2, Number 2

We would like to present one of our more popular newsletters, one that addresses the cornerstone terms to commercial real estate investments. Following are terms and definitions that may help you make the right decision about property purchases or leases.

CAP Rate (aka Capitalization Rate)
Capitalization Rates measure the ratio between the net income produced by an asset and its capital cost (the original price paid to own the asset). The rate is calculated as follows:

Net Income / Capital Cost = Capitalization Rate

So, when a building is purchased for $1,000,000 and produces $100,000 in positive net cash flow (the amount left over after fixed costs and variable costs are subtracted from gross lease income) during one year, then: $100,000 / $1,000,000 = 0.10 = 10%. That asset's "Cap Rate" is ten percent. Capitalization rates are a measure of how fast an investment will pay for itself in net cash flows. In the example above, the purchased building will pay for itself in ten years.

CAM Charges
Costs in multi-tenant commercial buildings that are passed on to the tenant are called common area maintenance charges or CAM charges. CAM charges are paid proportionately by each tenant for the upkeep of areas designated for the use and benefit of all tenants, and include items such as parking lot maintenance, security, snow removal, and common area utilities. Some tenants negotiate that they won't have CAM charges. But, for those tenants whose rent includes CAM, they're handled pursuant to the lease in a variety of ways and can be due in advance or paid in arrears. For accounting purposes, CAM charges are typically reflected in the cash flow as "CAM reimbursement." Although they're indicated as an income item, they're essentially offsetting the corresponding expense items included in the operating expenses for the property.

Lease Options
There are several different lease options available to landlords and tenants. And, they generally fall into one of the following three categories:

Gross Lease
In a gross lease, the landlord pays for almost all of the operating expenses of the property.

Modified Gross Lease
Some of the expenses of owning and operating the building are passed through directly to the tenants. Examples of modified gross leases include leases where the landlord pays all operating expenses except for certain items such as utilities, parking, or janitorial expenses.

Net Lease
These provide for the tenant to pay for the majority of the costs of operating the building, including property taxes, insurance, and maintenance costs. Those leases in which the tenant pays virtually all costs associated with operating the building are called triple net leases.