If you need to diversify your portfolio by acquiring triple net real estate, but you aren’t familiar with investment terminology for commercial income property, it is important to learn the definitions of key terms that property brokers use to discuss US investment property with clients.
Becoming familiar with the terms below will help make consultations with your broker more productive.
- 1031 Exchange – A transaction in which investors exchange properties with each other to acquire property without paying capital gains tax. If you have an income property that you wouldn’t mind trading for another property that better suits your needs, ask a broker about the different types of 1031 exchanges.
- Capitalization Rate – The ratio of the net operating income of a property to the purchase price or value of the property (e.g., a $2 million property with a net operating income of $140,000 has a capitalization rate of 7%). A fair rate is considered to be in the range of 5.5 -7%, although higher rates are available.
- Effective Age – The age of property based on its condition and utility. From an investment perspective, old property that is well designed and cared for can have a lesser age than new property that is shoddily built and poorly maintained. The real age of a property is often less important than its effective age.
- Escalation Clause – A clause in a lease that permits the adjustment of a price or rent based on an event or index. For example, a lease may have a provision for rent to be discounted due to certain conditions in the tenant’s industry, or raised due to an increase in rent prices for the type of triple net real estate property the tenant inhabits.
- Investment Grade – A property whose tenant has a Standard and Poor’s (S&P) credit rating of at least BBB-. While acquiring investment grade US investment property is the preferred choice, it should be noted that some profitable tenants lack an S&P rating because they lack enough long-term debt to justify a rating.
- Market Rent – The rent that a property would likely generate in the open market. Market rent is calculated based on rents paid and rents asked for as of the date of the appraisal. When acquiring a property that is near the end of the lease period, it is important to compare the current rent to the market rent.
- Net Lease – A lease that transfers one or more property expenses, in addition to rent and utilities, to the tenant. A single net lease transfers property taxes; a double net lease transfers property taxes and building insurance; a triple net lease transfers property taxes, building insurance, and property maintenance.
- Net Operating Income – Income that exists after all operating expenses are subtracted from gross income before mortgage debt service and book depreciation have been subtracted. Determining a prospective tenant’s net operating income is helpful for assessing its ability to afford the lease.
Contact Westwood Net Lease Advisors – Real estate investment brokers frequently use the terms above to discuss investment opportunities. If this is your first time acquiring US investment property, and you are unclear about the meaning of certain investment terms and concepts, Westwood Net Lease Advisors is here to answer your questions.
