Commercial & Investment Real Estate Term Definitions
Absorption – The amount of inventory or units of a specific commercial property type that become occupied during a specified time period (usually a year) in a given market, typically reported as the absorption rate.
Amortization – The repayment of loan principal through equal payments over a designated period of time consisting of both principal and interest.
Annual debt service (ADS) – The total amount of principal and interest to be paid each year to satisfy the obligations of a loan contract.
Annual percentage rate (APR) – The true annual interest rate payable for a loan in one year taking account of all charges made to the borrower, including compound interest, discount points, commitment fees, mortgage insurance premiums. It also takes into account the time at which the principal is repaid (especially when payments of principal are made in installments throughout the year, but interest is charged at the beginning of the year), but not the actual expenses incurred by the lender in making the loan and recharged to the borrower. (Encyclopedia of Real Estate Terms 2nd Edition, Damien Abbott)
Assessed value – The value of real property established by the tax assessor for the purpose of levying real estate taxes.
Average annual effective rate – The average annual effective rent divided by the square footage.
Average annual effective rent – The tenant’s total effective rent divided by the lease term.
Balloon payment – The final payment of the balance due on a partially amortized loan.
Capitalization rate – A percentage that relates the value of an income-producing property to its future income, expressed as net operating income divided by purchase price. Also referred to as cap rate.
Capital expenditures – Property improvements that cannot be expensed as a current operating expense for tax purposes. Examples include a new roof, tenant improvements, or a parking lot—such items are added to the basis of the property and then can be depreciated over the holding period. Distinguished from cash outflows for expense items such as new paint or plumbing repairs (operating expenses) that can be expensed in the year they occur.
Capital Stack – A description of the totality of capital invested in a project, including pure debt, hybrid debt, and equity. The stack is described as containing the most risk at the top, traveling down the stack to the position with the least risk. Higher positions in the stack expect higher returns for their capital because of the higher risk. Lenders and equity stakeholders are highly sensitive to their positions in the stack.
Carried Interest or Promote – A “carried interest” (also known as a “promoted interest” or a “promote” in the real estate industry) is a financial interest in the long-term capital gain of a development. The “carried interest” is given to a general partner (GP), usually the developer, by the limited partners (LPs), the investors in the partnership. It is paid if the property is sold at a profit that exceeds the agreed-upon returns to the investors and is designed to give the developer a stake in the venture’s ultimate success. This serves to align the interests of the GP with the investors by allowing the GP to share in the “upside” of the real estate venture. It also serves to compensate the GP for the substantial risks taken during development of the project and during the period prior to sale of the property. Carried interest has traditionally been treated as capital gains income taxed at favorable capital gains rates.
Cash-on-cash rate – A return measure that is calculated as cash flow before taxes divided by the initial equity investment.
Common area maintenance (CAM) – Charges paid by the tenant for the upkeep of areas designated for use and benefit of all tenants. CAM charges are common in shopping centers. Tenants are charged for parking lot maintenance, snow removal, and utilities.
Core – These properties are typically the newest in the market and or in the best locations within their respective submarkets. These properties offer stable minimal risk opportunities. With the lowest level of risk and the lowest level of return.
Core Plus – These properties are in the middle of core and value add, so they are good properties that typically offer a slightly higher return from property income and property value appreciation.
Debt-coverage ratio (DCR) – Ratio of net operating income to annual debt service. Expressed as net operating income divided by annual debt service.
Depreciation – The loss of utility and value of a property.
Discount Rate – The percentage rate at which money or cash flows are discounted. The discount rate reflects both the market risk-free rate of interest and a risk premium.
Due diligence – The process of examining a property, related documents, and procedures conducted by or for the potential lender or purchaser to reduce risk. Applying a consistent standard of inspection and investigation one can determine if the actual conditions do or do not reflect the information as represented.
Equity Multiple – Ratio of total cash received to the cash invested.
EM = Total Cash Received/Total Cash Invested
Exchange – Under Section 1031 of the Internal Revenue Code, like-kind property used in a trade or business or held as an investment can be exchanged tax-deferred. Under a fully qualified Section 1031 exchange, real estate is traded for other like-kind property. All capital gains taxes are deferred until the newly acquired real estate is disposed of in a taxable transaction. The underlying philosophy behind the deferral of capital gains taxes is that taxation should not occur as long as the original investment remains intact in the form of (like-kind) real estate (like-kind refers to real property as such, rather than the quality or quantity of property).
Feasibility analysis – The process of evaluating a proposed project to determine if that project will satisfy the objectives set forth by the agents involved (including owners, investors, developers, and lessees).
Fully amortized mortgage loan – A method of loan amortization in which equal periodic payments completely repay the loan.
Gross rent multiplier (GRM) – A method investors may use to determine market value. This method calculates the market value of a property by using the gross rents an investor anticipates the property will produce at end of year 1 multiplied by a given factor (known as the gross rent multiplier extracted from the marketplace).
Highest and best use – The reasonably probable and legal use of vacant land or an improved property, which is physically possible, appropriately supported, financially feasible, and that results in the highest value.
Interest-only loan – A method of loan amortization in which interest is paid periodically over the term of the loan and the entire original loan amount is paid at maturity.
Internal rate of return (IRR) -The percentage rate earned on each dollar that remains in an investment each year. The IRR of an investment is the discount rate at which the sum of the present value of future cash flows equals the initial capital investment.
Loan-to-value ratio (L/V) – The amount of money borrowed in relation to the total market value of a property. Expressed as the loan amount divided by the property value.
Net lease – A lease in which the tenant pays, in addition to rent, all operating expenses such as real estate taxes, insurance premiums, and maintenance costs. Also see gross lease.
Net operating income (NOI) – The potential rental income plus other income, less vacancy, credit losses, and operating expenses.
Net present value (NPV) – The sum of all future cash flows discounted to present value and netted against the initial investment.
Non-recourse Loan – more broadly, is any consumer or commercial debt that is secured only by collateral. In case of default, the lender may not seize any assets of the borrower beyond the collateral. A mortgage loan is typically a non-recourse loan.
Partially amortized mortgage loan – The payments do not repay the loan over its term and thus a lump sum (balloon) is required to repay the loan.
Percentage lease – A lease in which the rent amount is based on a percentage of gross sales (monthly or annually) made by the tenant.
Physical depreciation or deterioration – A form or source of accrued depreciation considered in the cost approach to market value. The physical decay or deterioration of a property that may result from breakage, deferred maintenance, effects of age on construction material, and normal wear and tear. (Barron’s Dictionary of Real Estate Terms)
Present value (PV) – The sum of all future benefits or costs accruing to the owner of an asset when such benefits or costs are discounted to the present by an appropriate discount rate.
Promote or Carried Interest – A “carried interest” (also known as a “promoted interest” or a “promote” in the real estate industry) is a financial interest in the long-term capital gain of a development. The “carried interest” is given to a general partner (GP), usually the developer, by the limited partners (LPs), the investors in the partnership. It is paid if the property is sold at a profit that exceeds the agreed-upon returns to the investors and is designed to give the developer a stake in the venture’s ultimate success. This serves to align the interests of the GP with the investors by allowing the GP to share in the “upside” of the real estate venture. It also serves to compensate the GP for the substantial risks taken during development of the project and during the period prior to sale of the property. Carried interest has traditionally been treated as capital gains income taxed at favorable capital gains rates.
Real estate investment trust (REIT) – An investment vehicle in which investors purchase certificates of ownership in the trust, which in turn invests the money in real property and then distributes any profits to the investors. The trust is not subject to corporate income tax as long as it complies with the tax requirements for a REIT. Shareholders must include their share of the REIT’s income in their personal tax returns. (Barron’s Dictionary of Real Estate Terms and Encyclopedia of Real Estate Terms 2nd Edition, Damien Abbott)
Recession – A period of reduced economic activity or a general economic downturn marked by a decline in employment, production, sales, profits, and weak economic growth that is not as severe or prolonged as a depression. As a result, sales in real estate markets are slow, property values and price levels are flat or decreasing, and there is virtually no construction of new stock given excess supply of units in most real estate markets.
Recourse Loan – A recourse loan is a form of secured financing. It lets the lender go after the debtor’s other assets that were not used as loan collateral or to take legal action in case of default in order to pay off the full debt.
Rent concession – A period of free rent given to the tenant by the lessor.
Replacement cost – The estimated cost to construct, at current prices, a building with utility equivalent to the building being appraised, using modern materials and current standards, design, and layout.
Sale-leaseback – A leasing and financing strategy in which a property owner sells its property to an investor, then leases it back. This strategy frees capital that otherwise would be frozen in equity.
Securitization – The phenomenon of indirectly investing in real estate markets in ways that minimize risk (for example, investments made collectively with pooled money or the use of investment packages/funds, such as mortgage backed securities sold on the secondary financial market) as opposed to direct investments where investors own property or hold mortgages; a long-term trend that has had significant impact on real estate values.
Sunk costs – Investment costs that are committed and cannot be recovered.
Suspended losses – Passive losses that cannot be used in the current year are suspended for use in future years or at the time of sale.
Vacancy rate – The percentage of the total supply of units or space of a specific commercial type that is vacant and available for occupancy at a particular point in time within a given market.
Value-Add – These properties typically have some operation or vacancy issues and are usually outdated. These properties can be bought at a better basis and additional capital expenditures can be made to improve units and bring rents to market rate.
Weighted average cost of capital (WACC) – The average cost of capital (whether equity or debt), taking into account the relative proportions of each source of capital. (Encyclopedia of Real Estate Terms 2nd Edition, Damien Abbott)
Yield – A measure of investment performance that gauges the percentage return on each dollar invested. Also known as rate of return.
Zoning – The designation of specific areas by a local planning authority within a given jurisdiction for the purpose of legally defining land use or land use categories.