Find answers to some of the most common questions about commercial real estate investing.
Congress first introduced Real Estate Investment Trusts, or REITs, in 1960 for the purposes of allowing the general public an opportunity to invest in income-producing real estate. A REIT is a portfolio of large-scale properties, which has many of the characteristics of a mutual fund. Buyers purchase shares of these securities in the same way that they purchase shares of stocks. Additionally, REITs have favorable tax considerations and commonly offer a higher yield to investors. (REIT.com)
A Cap Rate, otherwise known as the Capitalization Rate, is a tool used to assess a property based on its current performance. To determine the Cap Rate, divide the net operating income (I) for the year by the appraised property value (V) [I/V = R]. (CMSA glossary)
An interest rate cap is a type of financial instrument that protects the holder from interest rate increases. This is normally used when short-term interest rates are anticipated to increase. The cap is generally tied to an index rate. Conversely, an interest rate floor is used in conjunction with a long-term note. These are commonly used by money managers who wish to receive a higher rate of return during a time period of decreasing short term rates.
An NNN-lease, or a Triple-Net Lease, is a lease whereby the tenant pays real estate taxes, expenses and maintenance fees in addition to the agreed upon rental rate. (CMSA glossary)
Adjustable rate loans, also known as floating or variable rate loans, are debts that do not retain a fixed rate of interest over the life of the loan. Floating rates are generally tied to an existing index (ex: 10-year treasury; LIBOR) and adjust periodically based on the loan terms.
A swap is an agreement between two parties in which a sequence of cash flows are exchanged over a predetermined period of time. Swaps are traded in the Over-The-Counter ("OTC") market and are generally executed by firms and financial institutions rather than individuals. The two most common varieties are interest rate swaps and currency swaps. An interest rate swap is the exchange of two cash flows of the same currency, with one cash flow tied to a fixed interest rate and the other tied to a floating interest rate. A currency swap is the exchange of principal and fixed interest payments in one currency for principal and fixed interest payments in another currency.
According to the IRS, a 1031 Exchange is a type of tax-deferred transaction whereby a property owner enters into an agreement to trade one or more assets for another asset(s) that is comparable in nature and/or character. In doing so, there is no gain or loss on the property, and the owner is not required to pay capital gains tax on the transaction.
Assets can be categorized based on numerous factors including geographic location, age, amenities, etc. General guidelines for determining these classifications exist, however there is no universal criteria.
Class A office buildings are typically new or recently renovated and are located in a highly sought-after area of a major city, such as the central business district. Interior build outs generally feature tenant and common area spaces with high-end finishes and quality construction.
Class B properties are commonly found outside of the central business district. These assets are generally older than Class A projects and are average in terms of facilities, building materials, and interior finishes.
Class C properties are older than Class A and B properties and are normally located in suburbs or areas with lower demand. Benefits of Class C properties include competitive rental rates and strong occupancy rates.