Frequently used terms within the commercial real estate industry.
The amount of inventory or units of a specific commercial property type that become occupied during a specified time period in a given market, typically reported as the absorption rate.
A term used by the Securities and Exchange Commission (SEC) under Regulation D to refer to investors who are financially sophisticated and have a reduced need for the protection provided by certain government filings. Accredited investors include individuals, banks, insurance companies, employee benefit plans, and trusts. In order for an individual to qualify as an accredited investor, he or she must accomplish at least one of the following:
The original cost basis of property plus capital improvements, less total accumulated cost recovery deductions, and partial sales taken during the holding period.
An alternative investment refers to any investment which does not qualify as “traditional.” Traditional investments are widely considered to be stocks, bonds, and cash.
The repayment of loan principal through equal payments over a designated period of time consisting of both principal and interest.
The total amount of principal and interest to be paid each year to satisfy the obligations of a loan.
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, and mortgage insurance premiums.
An estimate of value, generally made by a professional appraiser, using a systematic approach or process in order to reach a conclusion.
The possibility or probability that a real estate investment will increase in value during the holding period.
The value of real property established by the tax assessor for the purpose of levying real estate taxes.
The average annual effective rent divided by a tenant’s square footage space.
The tenant’s total effective rent divided by the lease term.
The total amount paid for a property, including equity capital and the amount of debt incurred.
A request made to existing equity owners for additional money in order to fund deficits due to construction or operating costs, if cash flow is not otherwise deemed sufficient to do so.
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 can be depreciated over the holding period or the useful life of the improvement.
Gain on the sale of a capital asset like real property. Capital gains enjoyed on assets held for a long term (generally at least one year) often enjoy lower tax rates than ordinary income. Taxable income is derived from the sale of a capital asset. It is equal to the sales price less the cost of sale, adjusted basis, suspended losses, excess cost recovery, and recapture of straight-line cost recovery.
The capital stack refers to the legal organization of all of the capital placed into a company or secured by an asset through investment or borrowing.
The capitalization rate, or “cap rate,” is a formula used to determine the value of a real estate investment. The cap rate percentage is found by dividing the net operating income of a real estate asset (expenses minus income) by the current value of the asset. The cap rate is always calculated using the current value of the asset, rather than the purchased value of the asset.
The net cash received in any period, taking into account net operating income (NOI), debt service, capital expenses, loan proceeds, sale revenues, and any other sources and uses of cash. Real estate investments are often structured to deliver steady cash flow with dividends that are distributed to investors monthly, quarterly, or annually.
A common metric for measuring commercial real estate investment performance, which is sometimes also referred to as the cash yield. The cash-on-cash return rate can provide useful insight into the business plan for a property and the likelihood of receiving regular cash distributions over the course of an investment. The “cash on cash return,” also sometimes called the “equity dividend rate," is a simple ratio measurement of an investor’s return in relation to the cash actually invested.
Commercial real estate applies a simple grading system to assets to rate overall quality and key characteristics. Buildings are classified as A, B, or C, and that ranking is an important indicator to gauge a property’s competitive position in a marketplace and where it fits in relation to market value and rents. Class A represents the top tier in a particular market. Some of the key attributes of Class A properties include high-end construction and interior finishes, modern architectural design, state-of-the-art mechanical systems and technology, and a variety of property amenities.
Property designed for uses other than personal residential purposes. Examples include office, retail, multifamily, industrial, storage, hotel, and medical.
A method of determining the market value of a property by evaluating the costs of creating a property exactly like the subject.
An annual deduction based on the class life of an asset.
Crowdfunding is a new tool for raising money for businesses and an easier way to access such ventures for investors. As a result of the 2012 JOBS Act, real estate developers and owner/operators can rely on crowdfunding sites to solicit investments from high-net-worth investors who are qualified to make an investment in this market.
The quantity of investment opportunities available at a given time to a particular company or investor.
Debt investments refer to investing in a real estate loan. Those loans are backed by an underlying asset as collateral, such as land or a building.
The periodic required payments of principal and interest due on a loan.
Ratio of net operating income to annual debt-service, expressed as net operating income divided by annual debt service.
A written document that conveys title to real property.
Failure to fulfill an obligation or promise, or to perform specific acts.
In mortgage finance, a shortfall of funds recovered through the sale of property securing a foreclosed loan compared to the amount of debt, accrued interest, foreclosure expenses, and damages incurred by the lender.
Depreciation decreases the accounting value of the physical structure of a real estate asset, as most assets decline in value over time, but does not affect the market value of a property. In its most basic form, the physical improvements of a property may be depreciated over a 27.5-year period in an accounting method referred to as “straight line depreciation.” However, certain improvements (e.g. appliances and flooring) may be depreciated over a period as short as five years. Depreciation is utilized by real estate operators as a tax benefit tool, which allows an investor to utilize a passive “loss” from depreciating improvements to offset other passive income. The net result is a higher after-tax yield. As the tax benefits of depreciation are dependent upon an individual’s or entity’s taxable income, investors are strongly encouraged to consult a tax advisor.
Development is the process of building or adding to existing structures to increase the value of a property.
Payments made to investors periodically (e.g., monthly, quarterly, or annually), typically over the course of a calendar year, either from profits or interests payments.
The distribution waterfall is the order in which distributions are made to limited and general partners. It is a hierarchy delineating the order in which funds are distributed and may ensure that different types of investors have priority of payment compared to others within the same investment.
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.
A method of reducing risk by investing in assets that vary by asset class, duration, location, and risk.
The process of examining a property, related documents, and procedures conducted by or for the potential lender or purchaser to reduce risk. By 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 is essentially how much the stake in ownership on a property is worth; it is the difference between the current market value of a property and the amount owned by the owner on a mortgage (if any). As a mortgage gets paid off the owner’s equity grows. When a property is sold, the equity is the difference between the purchase price and the sale price. The market drives the property’s equity but improving and upgrading the property can increase it.
An agreement between two or more parties providing that certain instruments or property be placed with a third party for safekeeping, pending the fulfillment or performance of a specified act or condition.
The use of borrowed funds to acquire an investment.
A mortgage, deed of trust, or other encumbrance on an asset that has priority over all other encumbrances.
Costs that do not change with a building’s occupancy rate. They include property taxes, insurance, and some forms of building maintenance.
A lease in which the lessee pays a fixed rental amount for the duration of the lease term.
A loan with a repayment schedule of equal periodic payments that completely repay the loan over a scheduled time period.
Free cash flow is a measure of a property’s ability to generate cash after setting aside reserves for capital expenditures such as future development, tenant improvements, and leasing commissions.
An estimate of what a sum of money today would be worth in the future assuming a specified rate of interest.
An evaluation of the difference in the demand and supply of space for a particular type of commercial property in a given market area where gaps are expressed as the amount of square footage demanded less the amount of square footage available in a given period of time.
A tangible object of worth that is owned by a business or individual.
A hold period is the anticipated time investors will be involved with the investment until the underlying property is re-sold. It is important to read the offering documents for each investment opportunity for a deeper understanding of the hold period for each investment.
Additions to raw land or a structure that tend to increase the property’s value.
A method to estimate the value of an income-producing property by converting net operating income into a value. The cap rate is divided into the net operating income to obtain the estimated value.
A lease in which the rental amount adjusts accordingly to changes and/or movements in a price index, commonly the consumer price index.
Commercial properties that are used for the purposed of production, manufacturing, or distribution.
The Internal Rate of Return (IRR) is the metric most commonly used to measure profitability of a potential real estate investment. The IRR for an investment is the percentage rate earned on each dollar invested for each period it is invested. Ultimately, IRR gives an investor the means to compare alternative investments based on their yield.
The Jumpstart Our Business Startups Act, or JOBS Act, is a law intended to encourage funding of small businesses in the United States by easing many of the country's securities regulations. It was signed into law on April 5, 2012. Title III, also known as the Crowd Fund Act, has drawn the most public attention because it creates a way for companies to use crowdfunding to issue securities, something that was not previously permitted. It also lifted the ban on “general solicitation” and advertising of some kinds of private placements of securities such as real estate LLCs. This provision allows broader marketing of placements, as long as companies only sell to accredited investors (based on income, net worth or written confirmation from a specified third party).
Schedule K-1 is a tax document used to report the incomes, losses, and dividends of a partnership. The Schedule K-1 document is prepared for each individual partner and is included with the partner’s personal tax return.
A legal claim against property making it security for the payment of a debt, judgment, mortgage, or taxes.
A legal organizational form offering limited liability protection for the owners, which may be treated as a partnership for deferral income tax purposes.
A partnership structure where “limited partners” are passive investors whose liability is limited to the amounts invested, but where at least one partner is a “general partner” whose liability is general in nature and not limited.
Liquidity refers to the ease with which an asset can be purchased or sold. Marketable securities that are traded in high volume tend to be the most liquid or easy to trade without creating wild fluctuations in price.
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.
The amount of principal remaining to be paid on an amortizing loan at a given time.
The date upon which a loan must be paid in full.
A loan that is of lesser priority than a first mortgage or deed of trust. It may also have loans subordinate to it (hence "mezzanine"). Generally has the same priority as if it were called a second mortgage.
Mezzanine Debt is generally a loan that is secured by a property and senior to any equity, but junior to the senior loan on the property. Preferred Equity, on the other hand, is an equity investment in the property-owning entity. It is not secured by the property but rather by an interest in the entity investing in (or owning) the property.
A written legal instrument that creates a lien upon real estate as security for the payment of a specified debt.
Housing units that accommodate more than four families or households.
In commercial real estate, the equity multiple is defined as the total cash distributions received from an investment, divided by the total equity invested.
The Net Asset Value per share represents the estimated value of a single share based on a variety of factors.
The potential rental income plus other income, less vacancy, credit losses, and operating expenses.
The sum of all future cash flows discounted to present value and netted against the initial investment.
The actual dollars paid out by the tenant to occupy the space. It can be expressed in either pre-tax or after-tax dollars.
An off-market sale is a term used to define a property that is selling, or has already been sold, without any public advertising.
A commercial property type used to maintain or occupy professional or business offices.
Cash outlays necessary to operate and maintain a property. Examples of operating expenses include real estate taxes, property insurance, property management and maintenance expenses, utilities, and legal or accounting expenses. Operating expenses do not include capital expenditures, debt service, or cost recovery.
An aggressive investment strategy that in real estate generally signifies investing in properties that require a high degree of rehabilitation in order to eventually earn “market” rental rates.
Income such as salaries, interest payments, dividends, and many other items that are taxed at regular rates.
The total amount paid for a property, including equity capital and the amount of debt incurred.
A loan secured by real property, with a stated interest rate that also provides for a share to the lender in annual net cash flow, gain on sale, or proceeds from refinancing the property.
One or more people or entities pursuing a common business enterprise for profit.
Passive income (also known as residual or recurring income) is commonly used to refer to income that continues to be earned even after the work is done.
In a passive real estate investment, the investor makes an upfront capital investment as an equity-based vehicle and then receives an ownership stake in that investment, from which the investor is paid dividends or other types of regular income that is somewhat automated.
A group of investment assets.
A rate of return paid to investors before the sponsor gets paid any distributional cash flow.
The portion of a loan payment used toward reducing the original loan amount.
For assets that are mortgaged with a fully amortizing loan (in most cases over a 25-30-year period), the property’s revenues service an outstanding debt that reduces with each month’s payment.
The sale of securities to a small number of select investors as a way of raising capital.
A legal document that states the objectives, risks and terms of an investment involved with a private placement. This document includes items such as a company's financial statements, management biographies, a detailed description of the business operations, and more. An offering memorandum serves to provide buyers with information on the offering and to protect the sellers from the liability associated with selling unregistered securities.
A financial model often used in real estate to predict future cash flows and total investment returns.
A financial document that contains a written promise by one party to pay another party a definite sum of money.
Real estate includes a parcel of land and any of its permanent structures (buildings, parking lots, etc.).
Also known as residual or passive income, recurring income is earned by creating or acquiring an asset that continues to pay profits regardless if there is still active work being done to the asset.
A SEC regulation governing private placement exceptions.
A REIT is 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.
Properties used exclusively to market and sell consumer goods and services.
The probability that actual cash flows from an investment will vary from the forecasted cash flows.
Schedule K-1 is a tax document used to report the incomes, losses, and dividends of a partnership. The Schedule K-1 document is prepared for each individual partner and is included with the partner’s personal tax return.
The U.S. Securities and Exchange Commission is an agency of the United States federal government.
A retirement account in which the individual investor is in charge of making all investment decisions. The self-directed IRA provides the investor with greater opportunity for asset diversification outside of the traditional stocks, bonds and mutual funds, such as real estate. In addition to the tremendous IRA benefits (tax-free profits, tax deductions, asset protection and estate planning), you are able to invest tax-free in investments that you know and understand, which through the power of compounding interest, will create lasting wealth for you and your family.
Senior debt is generally secured at the base of the capital stack. Because it sits at the base of the capital stack, it must be repaid first.
A sponsor is the managing leader of a real estate project who researches the market, identifies a property to be acquired, organizes the investors and bank financing in order to make the purchase, oversees the subsequent management of the property, and determines when it is to be sold.
A professional financial services group formed temporarily for the purpose of handling a large transaction that would be hard or impossible for the entities involved to handle individually. Syndication allows companies to pool their resources and share risks.
Another key advantage of real estate investing is that it is a good way to diversify portfolios that are backed by hard assets. Real estate is not the same as buying shares in a company that may be here today and gone tomorrow.
Occupancy is generally referred to as a percentage of the total square feet or units leased—it is a building’s revenue source.
The right to the ownership and possession of any item that may be legally recognized as belonging to someone or something. In its most basic sense, title is the recognition of ownership.
Insurance that covers the loss of an interest in a property due to legal defects and that is required if the property is under mortgage.
Outlined in the 2012 JOBS Act, Title III instructed the SEC to create an exemption from registration that, when implemented, will enable issuers to engage in crowdfunding equity offerings to the general investing public.
A lease agreement that designates the lessee (the tenant) as being solely responsible for all of the costs relating to the asset being leased in addition to the rent fee applied under the lease.
A legal entity creating fiduciary relationship in which one party, known as a trustor, gives another party, the trustee, the right to hold title to property or assets for the benefit of a third party, the beneficiary.
A person or firm that holds or administers property or assets for the benefit of a third party.
Underwriting is the process by which real estate investments are evaluated to determine their viability.
An investor who does not meet the wealth requirements of an accredited investor set forth by the SEC.
Value-add commercial real estate investments typically target properties that have in-place cash flow, but seek to increase that cash flow over time by making improvements to or repositioning the property. This could include making physical improvements to the asset that will allow it to command higher rents, increasing efforts to lease vacant space at the property to quality tenants, or improving the management of the property and thereby increasing customer satisfaction or lowering operating expenses where possible. Once the owner/operator has successfully increased the net operating income at the property, they typically seek to sell the asset to capture the resulting appreciation in value.
A measure of investment performance that gauges the percentage return on each dollar invested.
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.