Specialization is a wonderful thing.  It gives us stature and credibility in our professions.  But sometimes if we are willing to broaden our skill set just a bit we can also broaden our potential market and enhance our business. 

Some mortgage and real estate brokers who specialize in residential property seem almost inclined to flee from prospective clients who want to talk about commercial or income-producing property.  “Too many numbers . . .  A language of its own . . .  I’ll bet there’s a secret handshake, too.”

On the one hand it may not make sense for you to try to learn thoroughly the nuances of commercial real estate if that’s not your primary market; but it’s not at all unreasonable for you to develop a basic understanding so that you can hold up your end of the conversation, both with a client and with a seasoned commercial broker – someone with whom you can collaborate profitably on a transaction.

If there were one principle about commercial and income property you should learn, it would be this: 

What investors buy (and what lenders finance) is the property’s future income stream. 

Cash is king.  It determines the value of the property, whether the investment is a success, and whether the lender gets paid.  Location, property condition and all of the factors you think about as being important to residential property still matter, but with investment property they matter insofar as they enhance or detract from the property’s expected future stream of income.

There must to be more to it than that, right?  Of course, and while I can’t give you an education in commercial real estate in this brief article, I can give you a punch  list of essential terminology with which you can start:

• Net Operating Income (NOI) – The property’s potential gross income, less losses due to vacancy and collection, less all operating expenses such as property taxes and insurance (but not mortgage interest or depreciation). NOI is probably the single most important piece of information about an income property.

• Annual Property Operating Data (known as the APOD form) – A form that shows income, vacancy loss, operating expenses and NOI.  It’s like a P&L for an income property.

• Capitalization Rate – A rate-of-return measure which, when used in conjunction with the NOI, will give you an estimate of the property’s value.

• Debt Coverage Ratio (DCR) – The ratio between the property’s annual Net Operating Income and its annual debt service (i.e., mortgage payments).  There’s that NOI yet again.DCR is an essential part of the mortgage underwriting because the lender wants to know that you’ll have not just enough but more than enough cash to cover the mortgage payments.  The minimum acceptable DCR varies among lenders and property types, but in general a property is unlikely to get financed with an expected DCR less than 1.20.

Now that you have the short list of key terms, it shouldn’t be hard for you to find examples as well as more complete discussions of how these are used. Armed with a bit more knowledge, you can stay in play when it comes time for you to work with a commercial specialist to help one of your customers.

And the next time someone calls and says, “Can you help me with financing on an apartment building?” you can just say, “Send me the APOD and I’ll see what we can do.”

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