Commercial and Investment Real Estate
What this domain tests
This domain tests the analysis of income-producing property: leases, operating statements, returns, and due diligence. Expect questions on lease structure, NOI, cash-on-cash return, and the risks specific to commercial transactions.
Core rules and concepts
- Lease types. In a gross lease the landlord pays operating costs. In a net lease the tenant pays some or all of taxes, insurance, and maintenance. A triple net lease shifts taxes, insurance, and common area costs to the tenant. Percentage rent adds a share of sales above a breakpoint.
- Lease terms that matter: term and renewal options, escalation clauses, exclusivity, assignment and subletting, tenant improvement allowances, and estoppel certificates.
- Operating statement. Effective gross income = potential gross income − vacancy and credit loss + other income. NOI = effective gross income − operating expenses. Below NOI come debt service, capital expenditures, and taxes.
- Returns. Cash-on-cash return = annual pre-tax cash flow ÷ equity invested. Cap rate = NOI ÷ price. Internal rate of return accounts for the timing of all cash flows including resale.
- Due diligence includes rent roll verification, estoppels, lease audits, environmental review, physical inspection, and title review. Estoppel certificates confirm lease terms and prevent later disputes.
- Risk factors include tenant concentration, rollover risk, lease incentives, deferred maintenance, and interest rate exposure on refinancing.
Worked example
A buyer pays $2,400,000 for a small retail plaza with NOI of $168,000, financing $1,600,000 and investing $800,000 equity. Annual debt service is $118,000.
Reasoning: cap rate = 168,000 ÷ 2,400,000 = 7%. Pre-tax cash flow = 168,000 − 118,000 = $50,000. Cash-on-cash = 50,000 ÷ 800,000 = 6.25%. Note the cash-on-cash is below the cap rate because debt service consumes part of NOI. If one tenant representing 40% of income vacates, NOI falls sharply and the cap rate paid no longer reflects risk; tenant concentration is the key due diligence question.
Traps that cost marks
- Deducting capital expenditures or debt service when computing NOI.
- Confusing cap rate with cash-on-cash return.
- Ignoring vacancy and credit loss in effective gross income.
- Skipping estoppel certificates and relying on the seller's rent roll.
- Overlooking tenant concentration and rollover risk.