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What Does Cap Rate Mean?

Cap rate, NOI, ROI: what does it all mean?

You’ve heard it before, or maybe you already know from experience: investing in real estate builds wealth. And while diving into the world of commercial real estate investments may seem unachievable, there are ways to start small and build a portfolio over time. 

To get there, we want to help you build a foundation of knowledge.  To do that, let’s define common commercial real estate terms. Email me with questions – or post them on our social media pages. We want to demystify the world of commercial real estate. 

First, we’re starting with the basics that you’ll hear a lot. 

  • CRE is easy – it stands for commercial real estate. 
  • Next, ROI means Return on Investment, and it’s used in lots of industries. (Not just real estate.) Basically, ROI is the money you make on an investment after accounting for all expenses. ROI is an important measure of how much your investment paid off. 
  • NOI stands for Net Operating Income. NOI means all rent revenues from a property minus the operating expenses like maintenance, insurance, and taxes. This figure does not take into account the lending costs or income tax related to a property. 
  • Cap Rate is short for Capitalization Rate. Cap Rate is used to calculate a property’s ROI.  The formula to get a Cap Rate is NOI divided by the price of the property.  In today’s commercial market, most Cap Rates we see fall in the 5% to 8% range.
  • Finally, Vacancy Rate is a percentage of all available units in a property or in a market. The formula is the number of vacant units divided by all units and it can also be an economic indicator.  Montana’s major cities have experienced painfully low vacancy – meaning lots of opportunities for developers but also lots of challenges for renters.

That’s the beginning of useful terms to know when investing in commercial real estate.

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