Real Estate Investing Glossary
An investor with a certain level of income or net worth who is thus able to participate in a private placement of securities (such as membership interests in a limited liability company) without being counted toward the maximum number of investors that are otherwise permitted in an offering exempted under Regulation D of the Securities Act of 1933. Such an investor does not need to meet the “sophistication and experience” requirements that are applicable to other investors, and if the securities in an offering are sold only to accredited investors, then there are no special information requirements.
The most common accreditation criteria for an individual includes (roughly):
- an individual with income exceeding $200,000 in each of the two most recent years (or joint income with his/her spouse exceeding $300,000 in each of those years) and a reasonable expectation of reaching the same income level in the current year; OR
- an individual with a net worth (or joint net worth with his/her spouse) exceeding $1 million, excluding the person’s primary residence.
For additional information on who qualifies as an accredited investor, including how an LLC, Corporation, or Trust can qualify as “accredited investors,” see http://www.sec.gov/answers/rule506.htm.
To accumulate or increase; generally, refers to payments owed but which have not yet been paid. For example: XYZ Corporation borrowed $1 million at 6% interest, payable annually at the end of the year (i.e., $60,000 per year). Each month $5,000 of interest on the loan (1/12th of the annual total) accrues.
An estimate of value, generally made by a professional appraiser (certified to meet certain education, experience, and knowledge requirements) who uses a systematic approach or process (including the analysis of market data) in order to reach a conclusion. An appraisal of a property might be made not only to determine a reasonable offering price in a sale, but also to determine an appropriate loan size of a loan, to allocate a purchase price between land and building (improvements), to determine an appropriate amount of hazard insurance, or for estate tax purposes at the owner’s death.
Without Guarantees as to condition, as in a sale. May signal a problem in condition, or may merely indicate that the seller is not in a position to attest as to the property’s condition (s in a sheriff’s sale following a foreclosure). Premises must be accepted by a buyer or tenant as they are, including physical defects (other than hidden — or latent — defects).
Example: Henry purchases a building from Michael with the understanding that the building is to be conveyed as is. When Henry discovers that the roof leaks, Michael is not legally responsible for repairs.
The amount left over after subtracting the amount owed (on a loan) or the amount remaining already paid (in an account).
Example: A current loan balance of $95,000 means that loan payments have reduced the outstanding debt to that amount.
Example: A balance of $25,000 in a depositor savings account represents the amount deposited, plus interest earned, less any amount withdrawn.
An investment program in which funds are invested into an entity without investors knowing which properties will be purchased.
Example: Each of 100 investors contributes $5,000 into a project. The sponsor has not yet located the properties to be purchased, so the investment money is said to be placed in a blind pool.
Buy and Hold
Refers to longer-term equity investing, meaning that investors will take an ownership stake in a property (as opposed to being a lender or other lienholder) and hold that position for some period of years while the property is managed toward improved performance and returns. “Buy and hold” investments can be contrasted to “fix and flip” purchases, where investors seek only to make some basic repairs or improvements and then to sell the property as quickly as possible.
.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.
Example: Karen buys an investment property for $100,000 from which she earns ordinary income of $8,000 annually. After three years, she sells the property for $140,000. The $40,000 gain on sale is reported as a long-term capital gain on her tax return and is taxed at a rate that is less than the tax rate on the rental income she had earned earlier.
Periodic payments available to an equity investor, after deducting all other expenses applicable to rental income, including operating and financing expenses. Can be contrasted with net operating income, which deducts from gross rental income the various operating expenses, but which does not also factor in the effect of financing expenses.
Cash on Cash Return
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. The cash on cash ratio is determined by dividing the before-tax cash flow (net operating income less debt payments) and dividing it by the initial equity investment. For example, if the net operating income is $150,000, the debt service is $50,000, and the amount initially invested is $1 million, then:
(Net operating income less debt service) / initial equity investment = ($150,000 – 50,000) / $1,000,000 = 10% cash on cash return
Property designed for uses other than personal residential purposes, often times related to business activity. Commercial property includes (among other things) retail shopping centers, multi-family apartment buildings, office buildings, hotels and motels, and self-storage facilities.
Comparative Market Analysis
Sometimes called a competitive market analysis, this is an estimate of the value of a property using some indicators taken from sales of comparable properties (such as price per square foot). These value estimates, similar to a broker’s price opinion, are not appraisals and do not meet the standards of appraisal as defined by regulatory bodies.
Example: Although real estate brokers and agents may not perform appraisals in most states because they are not appropriately certified or licensed), often estimate the value of a subject property using a comparative (or competitive) market analysis in order to help their clients set listing prices and agree on selling prices.
An evaluation of a person’s capacity (or history) of debt repayment. Generally available for individuals from credit repayment histories and similar institutionally reported data. Some people argue that conventional credit reports are too limited in their focus because they do not include payment histories with respect to rents, utilities, and other basic household services.
Example: A credit report showing no late mortgage payments within the last 12 months may well mean that a person will be assigned a good credit score (perhaps a FICO score of 660 or above). This would be a good credit rating to have when applying for a new loan.
A number that purports to predict the probability that a person will repay a loan. Generally, the higher the number, the better risk the individual is considered to be. The score may determine whether the person gets the loan and how favorable the terms will be. The score is estimated from information contained in the individual’s credit report. See also FICO.
Example: With a credit score above 720, Ms. Phillips was able to arrange a loan at a prime (favorable) mortgage rate.
Deed of Trust
A legal instrument used in many states in lieu of a mortgage, where legal title to a property is vested in one or more trustees to secure the repayment of a loan.
Example: Bob borrows $50,000 on his property from lender Larry. Bob provides a deed of trust that is held in the name of Honest Abe, a trustee. If Bob defaults, lender Larry will foreclose on borrower Bob to gain possession of the property.
Pertaining to the characteristics of the population, such as race, sex, age, household size, population growth, and density.
Example: As a first step in estimating the demand for new or existing housing units, a real estate company may would likely undertake a demographic study, which would review the current population density and rate of growth, the age distribution of the population, and average household size in that local market area.
A charge against the value of an asset relating to its estimated wear and obsolescence. The term is most often used to refer to tax code provisions that exclude from taxable income a portion (the depreciable amount) that can be attributed to “wasting assets.” In real estate, buildings and improvements constitute such assets; these things have a finite life, and thus can take a depreciation “deduction” not always available in other investment classes. The value of a property must therefore be allocated between the amount attributable to the building or other “improvements,” and that of the land. Land is deemed to have an infinite life (because it never goes away) and so is not depreciable. A tax depreciation deduction may even be claimed when the property’s value has increased.
Depreciation allows an investor to gain a tax deduction without having to make any cash payment. It thus provides an important benefit to real estate investors. It results in an adjusted tax basis for the property; this adjusted basis will result in some additional tax at the time of sale, but the tax will have been deferred and may well be at a lesser rate than would have earlier applied.
A reasonable effort to obtain accurate and complete information in advance of a major decision; in real estate, this usually refers to the inquiries made in advance of a purchase or investment in a property. Due diligence considers the physical, financial, legal, and social characteristics of a property and its expected investment performance. The underwriting of a loan or investment is a form of due diligence, in the sense that it constitutes a relatively detailed risk assessment of that loan or investment.
Example: A potential purchaser of a property sent some experts to perform a due diligence review of the property, including a review of the mechanical and electrical systems of a building, local market conditions and competition, and environmental hazards.
Example: An investor is considering making an investment through a real estate crowdfunding company. As part of his due diligence, he carefully reads the offering materials, listens to a pre-recorded webinar in which the sponsoring company presents the opportunity, and contacts the crowdfunding company with any additional questions he may have.
The legal form under which property is owned
Example: The benefits and risks of owning real property may vary depending on the type of entity that is formed. Among the options are:
- individual ownership (see Tenancy entries)
- joint venture
- limited liability company (LLC)
- limited partnership
- real estate investment trust
The interest or value that an owner has in a property that is over and above the mortgage or other liens against it. The equity interest is the true ownership interest in the property; that interest generally holds the right to control the various aspects of property ownership, although the mortgage or other lien interests may place limits on that control. Equity holders have a chance to earn relatively larger returns on investment than do debt holders; while the debt must be repaid first (and thus the equity holders bear more risk), any price appreciation of the property upon sale (after the debt is paid) goes to the equity holder.
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.
Example: The deed to the property and the purchase amount were both placed in escrow pending fulfillment of other conditions to the contract.
Fair Market Value
The most probable price that a property should bring in a competitive and open market under all conditions needed for a fair sale, assuming that the price is not affected by undue stimulus and that the buyer and seller are each acting prudently and knowledgeably. The fair market value is the theoretical highest price that a buyer would pay, and the lowest price a seller would accept, assuming that both parties were willing — but not compelled — to act.
Example: An appraisal of a home indicates that its fair market value is $150,000. In a normally active market, the home should sell for this amount if allowed to stay on the market for a reasonable period of time. The owner might, however, give the property to a relative. He might also grow impatient and sell the house for $140,000 — less than the price he could likely obtain if he kept the house on the market for a longer period. Conversely, an over-eager buyer might be found who would be willing to pay $160,000. If the owner were to provide unusually favorable financing, he might even be able to sell the property for $170,000.
A measure of borrower credit risk, compiled under a system originated by Fair, Isaac & Co. (i.e. FICO), that is commonly used by mortgage underwriters when originating loans on real estate. The score is based on (among other things) the applicant’s credit history and the frequency with which they use credit. Expressed as a number between 300 and 850, the score determines not only whether a loan may be approved but also what type of terms a lender might offer. See credit report.
First Lien (Mortgage or Deed of Trust)
A lien (often a deed of trust or a mortgage) that has priority over all other liens. In cases of foreclosure, the first mortgage will be satisfied before other mortgages.
Example: A property costing $100,000 is financed with a first mortgage of $75,000, a second mortgage of $15,000, and $10,000 in cash. If the borrower defaults and the property is sold upon foreclosure for $80,000, the holder of the first mortgage will receive the full amount of the unpaid principal plus legal expenses. The second mortgage will only receive any amounts remaining after the first mortgage has been satisfied, and in this example would not be paid back all of its principal.
Fix and Flip
A type of business / investment strategy involving the purchase of properties requiring some immediate repairs, which when made will hopefully translate into a more valuable property that can quickly be re-sold at a profit. This strategy can be contrasted to a “buy and hold” approach where the property is held for a longer period.
The process by which a lender gains possession of mortgaged land after the borrower has defaulted on a loan. Most states require that some notice be given to a borrower after his missing a required payment before the foreclosure process can begin; during this initial period the owner still has a right to redeem the property, but failing any such redemption, the foreclosure process begins. Statutory foreclosure (such as where deeds of trust are used) can be effected without recourse to courts, although laws still regulate the process. Judicial foreclosure submits the process to court supervision.
Total before subtractions. When subtractions are taken, the amount is net.
Examples: Gross sales price (before broker fees); gross income (before vacancy rates are factored in); gross leasable area (before subtracting common areas).
A rental of only the land. When the ground lease predates the mortgage, the ground lease generally has priority (unless it is specifically subordinated).
Example: The landowner, the Shawmoca Indian tribe, gives a 75-year ground lease to Josephine. Josephine pays rent of $5,000 per year and builds a store on the property. At the end of the 50-year period, however, the entire property (including the store that Josephine built) reverts (goes back to) to the Shawmoca Indian tribe.
The time span of ownership, usually for investment real estate.
Example: Some real estate investors prefer short hold periods (under 5 years) in an attempt to retain a high level of financial flexibility. Others hold property for longer periods, to reduce frequent transactions costs and to forestall depreciation recapture.
An asset that is not readily convertible to cash. Real estate is generally considered an illiquid asset because it may take an extended period of time to accomplish a sale, depending on market circumstances.
Additions to raw land that tend to increase the property’s value; similar to developments. Improvements include not only buildings but also public enhancements such as streets and sewers.
Real estate that generates rental income. Multi-family apartment buildings, retail shopping centers, office buildings, industrial properties, resort and recreational properties, self-storage facilities, and hotels are all considered income properties. By comparison, personal residences, schools, churches, parks, and undeveloped land not earning significant agricultural sales or extraction royalties are all not considered income properties.
Industrial properties include manufacturing facilities, warehouses, distribution centers, and research & development space. Manufacturing and R&D properties tend to be build-to-suit buildings that can be difficult to “re-tenant” without extensive modifications, while warehouses and distribution centers can be more generic buildings. As with office buildings and retail centers, industrial property leases tend to have long terms.
A loss in the purchasing power of money; an increase in the general price level. Generally measured by the Consumer Price Index (CPI), a statistic published by the U.S. Bureau of Labor Statistics.
Internal Rate of Return (IRR)
Abbreviated as “IRR,” the internal rate of return is the true annual rate of earnings on an investment, taking into account the time value of money using discounted cash flow analysis (similar to the application of compound interest). The formula requires a trial-and-error method for solution. In real estate, the IRR figure is used in buy and hold equity investments to include any profit expected to be gained upon the property’s sale from the price appreciation of the property (as opposed to “cash-on-cash” returns, which reflect only regular cash distributions).
Example: John sells for $200,000 land that he bought 4 years earlier for $100,000. The internal rate of return was about 19%; that is the annual rate at which compound interest must be paid for $100,000 to become $200,000 in 4 years.
Example: Mary received $3,000 per year for 5 years on a $10,000 investment. The internal rate of return was about 15%.
A charge against property making it security for the payment of a debt, judgment, mortgage or taxes; it is a type of encumbrance.
Example: David wants to buy a home, but needs a loan to complete the purchase. David offers a lender a mortgage, which would create a lien on the property as security (collateral) for the payment of the debt.
The restriction of one’s potential losses to the amount invested; the absence of personal liability.
Example: Steven buys a membership interest in a limited liability company (LLC) for $10,000. If the property owned by the LLC drops in value to less than the mortgaged loan amount, Steven can still not lose more than his initial $10,000 investment amount unless he separately agreed to provide a personal guarantee on the loan.
Limited Liability Company (LLC)
A legal organizational form offering limited liability protection for the owners and which may be treated as a partnership for federal income tax purposes. An LLC is often used as a way to own real estate because it provides many of the legal advantages of a corporation along with the tax advantages of a partnership.
A partnership structure where some 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 not so limited.
Example: If a property purchased through a limited partnership drops in value to less than the mortgaged loan amount, limited partners will lose only their initial investment, while a general partner will remain responsible for the balance of the loan and any other additional losses.
The ease with which assets may be converted into cash.
Example: Common stocks and U.S. savings bonds generally have good liquidity, since there is a ready public market for those securities and they are easily and quickly traded. Real estate and many types of collectibles, on the other hand, generally have poor liquidity, because the markets for those assets are less streamlined and because the sales process is typically a slower one.
Loan-To-Value (LTV) Ratio
The amount borrowed compared to the cost or value of the property purchased. Lenders often require that a loan-to-value ratio not exceed a specified amount, unless a borrower also purchases mortgage insurance.
Example: Susan borrows $75,000 of the total $100,000 purchase price of her home. The loan-to-value ratio is 75%.
A geographic region from which one can expect the primary demand to come for a property (or any product or service provided at a fixed location). Real estate companies often refer to a submarket area, meaning a very focused region, perhaps a specific suburban area, within a larger metropolitan area.
Example: A multi-family apartment complex can expect to draw its tenants from a certain market area — perhaps from persons working on that side of town, as opposed to persons working on the other side of town.
Example: A large super-mall has a larger market area than a smaller neighborhood shopping center. Shoppers can be expected to come from a larger regional area for the super-mall (which may contain a movie theater and large national clothing chains) than they would for a smaller neighborhood shopping center, which likely has restaurants, gyms and smaller service providers but which lacks appeal as a “destination” shopping center.
Multi-family buildings include any building that includes more than a single family residence, but in common usage the term generally refers to apartment buildings of more than four units. Multi-family residential buildings vary by location (urban or suburban) and size of structure (high-rise or garden apartments). Economic drivers of apartment buildings include demographic trends, home ownership and household formation rates, and local employment growth. Leases are typically short-term (one to two years), and adjust quickly to market conditions. Larger apartment buildings are only minimally affected by any single vacancy. Multi-family properties are generally considered to be one of the more defensive investment types within commercial real estate, though they are still subject to competitive pressures from newer construction.
Net Operating Income
The income from a property or business remaining after operating expenses (maintenance, insurance, utilities, etc.) are deducted, but without considering any financing expenses (debt service) or income taxes. Can be compared to gross income, on the one hand, which does not yet deduct for expenses, or net cash flow, on the other hand, which adjusts not only for operating expenses but also for debt service.
Example: A property produces rental income of $100,000. The various operating expenses for maintenance, insurance, property taxes, management, and utilities come to $60,000. The net operating income is $40,000.
The sum of an individual’s assets less the sum of all obligations; a measure of personal wealth.
Example: The Securities and Exchange Commission uses an individual’s net worth (excluding the value of his primary residence) as one criteria of determining whether that person is an accredited investor.
The percentage of total units that are currently rented. Contrast with vacancy rate.
Example: Today, the Beach Hotel has 90 of its 100 rooms occupied; its occupancy rate is 90%. Conversely, its vacancy rate is 10%.
Office buildings range from large multi-tenant structures in city business districts to single-tenant buildings (like a hospital’s medical office building). Rents and valuations are influenced by employment growth, a region’s economic focus (finance and high-tech centers need more office space), and productivity rates. Individualized tenant improvements are usually not very involved, but credit quality of tenants is key; re-leases of office space typically require some lead time to consummate. Office properties often have longer-term leases that can lag current market lease rates, so that “step-ups” (or step-downs) of rental rates are not infrequent when leases expire. Because these buildings are often leased to businesses (not just individuals), the tenants often demand special features in the leases, including rights of first refusal to rent contiguous space, signage rights, or even building purchase options.
Amounts paid to maintain a property. Excludes financing expenses, income taxes and depreciation.
Example: Operating expenses can include:
- maintenance costs
- management fees
- real estate (property) taxes
- hazard and liability insurance
An aggressive (or riskier) 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. Properties requiring a greater amount of repairs, or rehabilitation, are generally considered “high risk,” because the property has not yet proven whether it can indeed earn the rents that are forecast for it when it will be improved to the desired state.
Ordinary income is income that is taxed at ordinary income tax rates and does not qualify for capital gains tax treatment. It’s important to understand the difference between ordinary income and capital gain income because, generally, ordinary income tax rates are higher than capital gains tax rates.
Income such as salaries, interest payments, dividends, and many other items are considered ordinary income.
Charges to a borrower to cover the lender’s costs of issuing the loan. These costs can typically include the cost of obtaining a credit report, an appraisal or broker price opinion on the property, and expenses associated with obtaining title insurance.
Example: The lender issued a $50,000 mortgage loan and charged a 3% origination fee ($1,500).
An agreement between persons or entities to invest or do business together. Unless otherwise agreed, either partner may bind the other (within the scope of the partnership), and each partner is liable for all of the partnership’s debts. A partnership itself normally pays no taxes, but merely files an information return; the individual partners pay personal income tax on their share of the partnership’s income. This is contrasted with a corporation, which must pay taxes on its income, and whose shareholders must also pay taxes on any dividends or other distributions they receive from the corporation.
Example: Adam and Bill form a partnership to buy land. The partnership owns the property, rather than Adam or Bill, but it files only information returns for tax purposes, while Adam and Bill pay personal income taxes on their share of the partnership’s profits.
One who invests money but does not actively manage the business or property.
Example: Jones has neither time nor skills to manage the property that he wants to invest in. He forms a partnership with Smith, who is an experienced real estate syndicator and who will devote time and expertise to manage the property for profit. Jones contributes money, but not effort, so he is a passive investor.
A form of marketplace utilizing a technological infrastructure that enables distributed access to capital or, conversely, transactions. Peer-to-peer (or “P2P”) markets offer are emerging alternative to many types of more established marketplace models. There can be many variations, but a peer-to-peer marketplace typically utilizes the wide-reaching power of the internet to offer access to certain products or services to persons who might normally have had such access. They also offer providers of such products or services with a much broader “reach” to potential users or customers of such products or services.
An individual’s responsibility for a debt. Most mortgage loans on real estate are recourse, meaning that the lender can look to the property and to the borrower for repayment. This can be contrasted to nonrecourse loans, where a lender can only look to the security (the pledged property) for repayment.
Example: Paul borrowed $100,000 against land, thereby incurring a personal liability for the debt. Paul fails to make payments, so the lender foreclosed and sold the property for $70,000; Paul still owes 430,000, plus the lender’s legal expenses, as a personal liability. The lender can seek a deficiency judgment against Paul for that remaining loan balance.
A group of investment assets.
Example: Dan’s real estate portfolio consisted of equity shares of three retail shopping centers, two multi-family buildings, and one self-storage facility, and also included shares of loans on a hotel and two single-family residences.
Another term for note. A legal document that evidences a debt, specifying how much money is being borrowed and the terms and conditions under which it is to be repaid.
A rate of return (often in the 5-10% range) that is paid to investors before the sponsor gets paid any promote share of distributable cash flow. The preferred return is not a guaranteed dividend; sometimes the preferred return is not paid out because the property cash flow doesn’t allow it (for example, where the property is still under development). In such cases, the preferred return typically continues to accrue, and any unpaid amounts are ultimately recouped by the investor when the property is sold. It remains, however, a preferred (higher priority) payout as compared to other potential distributions.
The amount of money raised by a mortgage or other loan that still remains after some of that amount may have been amortized by earlier payments. Principal can be contrasted to the interest paid on the loan.
Example: Harry arranged a amortizing loan of $100,000 principal amount at a 6% interest rate. The first monthly payment is $1,200 and includes $500 interest and $700 of principal amortization; following the payment, the principal balance be $99,300.
A Real Estate Investment Trust, or REIT, is a real estate mutual fund, allowed by income tax laws to avoid the corporate income tax if it limits its investments to real estate or mortgages and meets certain other requirements such as annually distributing 90% or more of its income to shareholders. Some of these restrictions can limit the maneuverability of REITs, which also tend to focus only on “core” properties with limited capital appreciation potential.
The retail sector includes everything from smaller neighborhood shopping centers (encompassing, for example, a small grocery, pharmacy and a few restaurants or clothing stores) to large “super-regional” malls that have entertainment activities and can draw shoppers from a great distance. Retail properties are most broadly influenced by the state of the national economy generally, especially such indicators as employment growth and consumer confidence levels. More local factors include the property location and its traffic flow; population demographics; and local household incomes and buying patterns. Retail store leases frequently contain a base rent plus a “percentage rent” based on the tenant’s gross sales figures. Leases also often have long terms; as with office buildings, this means that after a while lease rates may lag current market rates, and step-ups may need to wait until lease expirations.
Uncertainty or variability; the possibility that returns from an investment will be less than forecast, or that invested principal might be lost. Diversification of investments provides some protection against risk.
Example: Types of risk in real estate include (1) business risk, involving the project type, its management, and its market area, and how each of these factors might affect rents, vacancies and operating expenses; (2) financial risk, meaning both the uncertainty of the equity return when debt financing is used and the variability of interest rates that might affect a property’s debt service or its ultimate sale price; (3) inflation and other universal “systemic” risks like war or significant political changes, (4) liquidity risk, meaning whether (and when) the investment can be “cashed out,” and (5) variance or sensitivity risk, referring to the degree of variability of any of the foregoing risks.
Risk vs. Return
A financial concept that attempts to compare the potential fluctuations of an investment with the projected return associated with it. Increased risks require that an investor demand increased returns in compensation; people don’t normally accept the same rate of return on a very risky investment that they can already get on a low-risk investment.
Example: An expected return of two (2) percentage points above the rates paid by U.S. Treasury bonds may be considered sufficient reward for investing in mortgage securities if the historical default rate of such securities has been at 1%.
Example: An expected return of ten (10) percentage points above the U.S. Treasury rates may be needed to invest in unsecured credit card debt, if the historical default rate on such debt has been at 5%.
Single Family Residence
In real estate, generally refers to a stand-alone property intended to house one family. Individual apartment or condominium units are usually thought of as being part of a multi-family building, even though individual units are usually occupied by a single family.
Also referred to as an “operator” or “syndicator,” 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. Sponsors are generally professional real estate companies that are accustomed to these varied tasks. Sponsors will usually themselves make some investment in the property (in addition to the other investors that make up the investing syndicate), but will also make some money from a “promote” interest in a portion of any improved cash flow enjoyed by the property under their oversight.
Evidence that the owner of real property is in lawful possession thereof; it is evidence of ownership. Usually a property owner transfers his title by means of a legal document called a “deed,” which must be in writing and meet other local requirements. A deed should convey good and marketable title; “good” means that the title is valid, and “marketable” means that it is reasonably free from doubt or litigation, so that it can be readily sold.
Example: Title to land does not mean merely that a person has the right of possession, because one may have the right of possession but not have title. Title is evidence of true ownership of the land, with all the rights that signifies.
Example: Karen sold land to Susan. Title to the property was transferred at closing by the deed that Susan received.
An insurance policy that assures good title is transferred in the course of a sales or financing transaction. This insurance covers the legal fees and expenses that may be necessary if a claim is made against one’s ownership of the property. Different title policies offer different extents of coverage; for example, one can purchase “standard” coverage or “extended” coverage.
There are two common types of policies: a lender’s policy that protects a lender (or the “mortgagee”) on the property, and a buyer’s policy that protects the buyer (or the “mortgagor”).
The costs associated with buying and selling real estate.
Examples: At the closing of a property’s purchase or refinancing, a party (typically the buyer or borrower) must pay for appraisal fees, broker commissions, legal fees, mortgage origination fees, recording fees, and title search fees.
In finance, a manner of doing business such that activities are fully disclosed and reported to investors. Such policies make it possible for potential investors to adequately estimate the risk, and to forecast the income, from investing.
Triple Net Lease
A lease in which the tenant is to pay all the operating expenses of the property, such as taxes, utilities, insurance, and repairs; the landlord receives a “net” rent. The debt service on the property and the landlord’s own income taxes are not considered operating expenses and remain payable by the landlord.
In real estate, generally refers to making an assessment of the risks and potential returns of a potential investment or loan. See also due diligence.
Example: The lender’s loan underwriter analyzed the loan submission package carefully, because she didn’t want her firm to take excessive risk.
An ownership right to use and possession of a property that may be shared among co-owners, with no single co-owner having exclusive rights to any one portion of the property.
Example: Ten investors form a tenancy in common and purchase a 100-acre tract of land. Each cotenant obtains an undivided interest in the property. All decisions as to the use and disposition of the land are made collectively by all cotenants. No single cotenant may unilaterally mortgage, develop, or sell a portion of the property.
The percentage of all units or space that is unoccupied or not rented. On a pro forma income statement, a projected vacancy rate is used to estimate the vacancy allowance. This allowance is then deducted from the potential gross income in order to calculate the “effective” gross income.
Example: In a college town, the apartment vacancy rate varied from 5% during the 9-month college term and 25% during the summer session. Overall, the average vacancy rate was 10%.
A real estate property categorization, or investment “style,” referring to properties requiring some degree of improvements in order to gain increased returns. “Value-add” generally refers to a property that is currently in less than stellar condition and in need of improvements that are of somewhat higher risk, such as performing more-than-usual renovations like upgrading exteriors and interiors and curing deferred maintenance. The “value-add” categorization implies higher risk than the category of “core plus,” but less than “opportunistic.” Returns on the properties will be driven both by current income and by expected capital appreciation.
Another term for the internal rate of return (IRR), a measure of an investment’s return rate that takes account of the time value of money.
A legal mechanism for local governments to regulate the use of privately owned real property by applying their power to prevent conflicting land uses and promote orderly development. Designated zones limit the type and intensity of permitted development.
Example: Before a tract of land may be developed, the intended use must be permitted under the existing zoning classification. If the proposed use is not permitted, the developer must apply for a variance, or re-zoning, generally following a public hearing and a recommendation from the local planning commission
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