Lutz Quick Guide: 5 Commercial Real Estate Terms Every Investor Should Know
When analyzing a commercial real estate opportunity, a few core metrics can reveal a lot about its performance, risk, and profitability.
Below, we’ve broken down five essential terms—complete with formulas and examples—to help you evaluate deals with confidence.
1. Cash-on-Cash Return (CoC)
Definition:
The annual pre-tax cash flow divided by the total cash invested. It shows how efficiently your cash is working for you.
Formula:
Cash-on-Cash Return = Annual Pre-Tax Cash Flow / Total Cash Invested
Example:
$50,000 ÷ $500,000 = 10% CoC Return
Why It Matters:
This metric helps compare income-producing properties and alternative investments on a cash-return basis.
2. Capitalization Rate (Cap Rate)
Definition:
A property’s expected rate of return based on its Net Operating Income (NOI) and purchase price.
Formula:
Cap Rate = Net Operating Income / Purchase Price
Example:
$160,000 ÷ $2,000,000 = 8% Cap Rate
Why It Matters:
Cap rates help gauge market value, returns, and risk. Lower cap rates often indicate stronger locations with more competition.
3. Debt Service Coverage Ratio (DSCR)
Definition:
Measures a property’s ability to cover its debt obligations from operating income.
Formula:
DSCR = Net Operating Income / Annual Debt Service
Example:
$150,000 ÷ $100,000 = 1.5 DSCR
Why It Matters:
Lenders typically look for a DSCR of 1.25 or higher to ensure a safety buffer. Anything below 1.0 signals negative cash flow.
4. Internal Rate of Return (IRR)
Definition:
The annualized return on investment over the full life of a project, factoring in timing and all cash flows (including exit proceeds).
Formula:
IRR is calculated by solving for the discount rate that sets Net Present Value (NPV) to zero—typically using Excel or financial software.
Why It Matters:
IRR is a powerful tool to compare deals with different timelines and payout structures. A higher IRR generally reflects a more profitable opportunity.
5. Breakeven Occupancy
Definition:
The minimum occupancy level needed to cover both operating expenses and debt service.
Formula:
Breakeven Occupancy = (Operating Expenses + Debt Service) / Gross Potential Income
Example:
$300,000 ÷ $400,000 = 75% Breakeven Occupancy
Why It Matters:
A lower breakeven occupancy means greater resilience during vacancy or rent drops.
Know the Numbers. Grow with Confidence.
Understanding these five key metrics—Cash-on-Cash Return, Cap Rate, DSCR, IRR, and Breakeven Occupancy—gives you a sharper edge when evaluating opportunities, working with lenders, or advising clients.
At Lutz Real Estate, we help investors, owners, and developers make smarter decisions through expert analysis, valuation services, and strategic support.
Need Help Modeling a Deal?
Our team can help you run the numbers, test assumptions, and structure smarter deals.
Contact Lutz Real Estate to get started.
