This refers to the Internal Revenue Code (IRC), Section 1031. It paves the way to avoid paying capital gains tax on the sale of real estate property under certain conditions. If an investor sells a piece of property, then reinvests the proceeds from the sale into a new purchase within certain parameters, no capital gains tax would be due on the original sale transaction.
The payment schedule to pay off a debt. For example, a 30-year amortization means that the debt would be repaid with 360 equal monthly installments.
An appraisal is an estimate of a property’s value as of a specific date. It is comprised of a combination of information, such as the asset’s condition, location, comparable assets and sales in the immediate vicinity, demand, scarcity, and utility of property, as well as, in the case of an income producing property, the potential cash flow from the property from rental income among other things. An appraisal report typically includes three methodologies for determining value: sales approach, income approach and cost approach.
An assumable mortgage is a type of financing arrangement in which an outstanding mortgage and its terms can be transferred from the current owner to a buyer. By assuming the previous owner's remaining debt, the buyer can avoid having to obtain his or her own mortgage.
Basis points are equal to one-hundredth of one percentage point. For example, 100 basis points = 1 percentage point.
Bridge loans are shorter term loans that are often used when repositioning or renovating a property or in cases where permanent financing is impractical due to timing restrictions, insufficient income, or property condition issues.
Capital Expense Budget (CapEx)
Improvements (as opposed to repairs) that will increase the value or useful life of the asset. A capital expenditure is typically amortized or depreciated over the useful life of the asset, as opposed to a repair, which is expensed in the year incurred.
Capitalization Rate (Cap Rate)
Unlevered initial return from the acquisition of a real estate asset calculated by dividing net operating income (NOI) by the sales price. For example, a property’s capitalization rate (cap rate) is 10 percent if it is purchased for $10 million and produces $1 million in NOI during one year.
Commercial Mortgage Backed Securities (CMBS)
CMBS loans are securitized in the secondary market via a fixed income instrument (i.e., a bond).
Debt Service Coverage Ratio (DSCR)
The debt coverage ratio is the ratio of the net operating income to the mortgage payment.
Debt Yield (DY)
The Debt Yield is Net Operating Income (NOI) divided by the loan amount.
Defeasance is type of prepayment penalty that is very common for CMBS loans. If a borrower sells the property that is serving as collateral prior to the loan’s maturity, the borrower must substitute the collateral with bonds in order to provide income to service the debt.
A government sponsored enterprise (GSE) that purchases and pools conventional mortgages, i.e., those not insured by the Federal Housing Administration (FHA), the Veterans Administration (VA), or the Farmer’s Home Administration (FmHA), but also buys mortgages from FHA, and then issues securities using the pool of mortgages as collateral. Fannie Mae was the first agency to pool mortgages backed by adjustable-rate mortgages and created the first pass-through collateralized by multifamily mortgages through a swap program. Holders of Fannie Mae certificates are guaranteed full and timely payment of principal and interest.
Financial Advisor (FA)
A financial advisor provides financial advice or guidance to customers for compensation. Financial advisors can provide many different services, such as investment management, income tax preparation, and estate planning.
A government sponsored enterprise (GSE) that is charged to buy mortgages to enhance their role in and provide liquidity to the secondary market for single family mortgages (i.e., mortgages not backed by a government agency) and then issues securities using the pool of mortgages as collateral. It also issues participation certificates (PCs), most of which are backed by pools of conventional mortgages, but some pools are comprised of mortgages that are insured by the Federal Housing Administration (FHA) and/or guaranteed by the Veterans Administration (VA). Holders of Freddie Mac PCs are assured timely payment of interest and eventual payment of principal.
Gross (or Modified Gross) Lease
A type of lease in which a landlord receives stipulated rent from a tenant and is obligated to pay all or most of the property’s operating expenses and real estate taxes.
A loan in which the borrower is only required to repay the interest accrued under the loan and does not have an obligation to repay the Principal until Maturity.
Letter of Intent (LOI)
A letter of intent is an agreement(s) between two or more parties before an actual agreement, such as a lease, is finalized. The intent is to protect both parties in the transaction until the transaction is executed.
Life Insurance Loans
These are loans provided by life insurance companies. They typically provide competitive rates and long loan terms. However, underwriting tends to be very conservative and LTV ratios tend to be lower versus other alternatives, such as CMBS Loans. Generally, borrowers must obtain loans through Correspondent Lenders.
The loan-to-cost (LTC) ratio is a metric used in commercial real estate construction to compare the financing of a project (as offered by a loan) with the cost of building the project. The LTC ratio allows commercial real estate lenders to determine the risk of offering a construction loan. Similar to the LTC ratio, the loan-to-value (LTV) ratio compares the construction loan amount with the fair-market value of the project.
The ratio between a mortgage loan and the value of the property pledged as security, usually expressed as a percentage.
London Interbank Offered Rate (LIBOR)
The short-term (1-year or less) rate at which banks will lend to each other in London. Commonly used as a benchmark for adjustable rate financing. LIBOR terms are usually for one, two, three or six months or one year.
Net Cash Flow
Net cash flow is the annual income produced by an investment property after deducting allowances for capital repairs, leasing commissions, and tenant improvements from net operating income.
Net Operating Income (NOI)
It is calculated by deducting Operating Expenses owed by the owner such as utilities, insurance, management fees, property taxes, repairs and maintenance /janitorial fees, from the income. The NOI of a property is measured on a pre-tax basis and excludes loan payments (both principal and interest), capital expenditures, tenant improvements, leasing commissions, replacement reserves, amortization, and depreciation.
Non-recourse protects the Borrower in the event that the Borrower defaults on the loan. In this case, the leander can seize the collateral but cannot seek out the borrower for any further compensation, even if the collateral does not cover the full value of the defaulted amount.
Permanent financing is obtained after completion of construction, usually to repay the short-term (non-permanent) construction loan.
Phase I Environmental Report
An assessment and report prepared by a professional environmental consultant that reviews the property to determine the presence of potential environmental hazards. This Phase I Environmental Site Assessment (ESA) provides a review and makes a recommendation as to whether further investigation is warranted (a Phase II Environmental Site Assessment).
A prepayment penalty is a clause in a mortgage contract stating that a penalty will be assessed if the mortgage is prepaid within a certain time period. There are several forms of prepayment penalties, including Step Down, Yield Maintenance, and Defeasance.
A pro forma forecasts expected income of a property based on present or projected figures.
Profit and Loss Statement (P&L)
The profit and loss statement is a financial statement that summarizes the revenues, costs and expenses incurred during a specified period, usually a fiscal quarter or year. P&L statement is synonymous with the income statement. These records provide information about a company's ability or inability to generate profit by increasing revenue, reducing costs or both. Some refer to the P&L statement as a statement of profit and loss, income statement, statement of operations, statement of financial results or income, earnings statement and expense statement.
Property Condition Assessment (PCA)
A PCA is a report that outlines how an organization can manage capital assets in order to improve its asset management operations. An asset condition assessment (ACA) is most commonly associated with organizations that manage physical assets, such as bridges, roads, and equipment, and is utilized to decide upon preventative maintenance or remedial work to preserve an object's value and extend its useful life. Asset condition assessment may also be referred to as a "facility condition assessment" when it pertains to a building.
Purchase and Sale Agreement (PSA)
A purchase and sale agreement is a legal contract that obligates a buyer to buy and a seller to sell the property.
A mortgage rate lock is an agreement between a borrower and a lender that allows the borrower to lock in the interest rate on a mortgage over a specified time period at the existing market interest rate.
Real Estate Investment Trust (REIT)
A REIT is a company that owns income-producing assets, such as apartments, shopping centers, offices and warehouses. It may also invest in air or water rights, unharvested crops, permanent structures and structural components that are part of a structure but don’t themselves produce income. Shares of REITs can be traded like stocks and can allow owners of the shares to participate in the real estate market.
Recourse gives the lender the right to ensure full repayment in the event that the borrower is unable to satisfy the debt obligation. Companies that issue recourse debt have a lower cost of capital, as there is less underlying risk in lending to that firm.
Funds set aside for replacement of wasting assets.
A line item in underwriting to account for future repairs or future property maintenance costs.
Smith Travel Research Report (STAR or STR report)
STR, formerly known as Smith Travel Research, is an American company based in Hendersonville, Tennessee, that tracks supply and demand data for multiple market sectors, including the global hotel industry. STR provides market share analysis for major hotel chains and brands in North America, Europe, Asia Pacific, Middle East and Africa.
The interest rate spread is the margin over the Index when calculating the Interest Rate.
A step-down is a one kind of a prepayment penalty on an existing commercial mortgage or other commercial property loan. Generally, this is a straightforward calculation based on the remaining balance. For example, a typical step-down might be 5 % of the outstanding balance in the first year, 4 % in the second year, 3 % in the third year, and so on. Most lenders will not charge a penalty in the last 90 days of the loan term.
Tenant Improvement/Leasing Commissions (TI/LC))
A tenant improvement (TI) refers to the improvements a commercial property owner makes to the interior of a rental space to suit the needs of a new tenant. This most specifically takes place in office and retail transactions, and not in multi-family loans. The cost of the improvements or changes may be paid by the property owner, the tenant, or both. This is determined during contract negotiation. If a real estate broker or agent is successful at closing a lease agreement between a landlord and tenant, they will receive a leasing commission (LC). The LC is an amount paid by the owner of the property based on a percentage of the lease value. For example, a tenant that signs a two-year lease for 4,000 square feet at $40 per square foot per year will have a lease value of $320,000 (4,000 sq. ft. * $40/sq. ft./year * 2). If the property owner is paying a 7% leasing commission, then the total commission that the real estate broker or agent will receive is $22,400 ($320,000 * 0.07). Ultimately, the leasing commission will depend on various factors, such as the amount of the lease, the property type, and most importantly, what the property owner has negotiated with the agent or broker.
Triple Net Lease (NNN)
A lease agreement where the tenant pays its pro rata taxes, CAM, and property insurance as well as all operating costs associated with the property.
US Treasury Rates
In the United States, the federal funds rate is the interest rate at which depository institutions (banks and credit unions) lend reserve balances to other depository institutions overnight, on an uncollateralized basis. Reserve balances are amounts held at the Federal Reserve to maintain depository institutions' reserve requirements. Institutions with surplus balances in their accounts lend those balances to institutions in need of larger balances. The federal funds rate is an important benchmark in financial markets. The interest rate that the borrowing bank pays to the lending bank to borrow the funds is negotiated between the two banks, and the weighted average of this rate across all such transactions is the federal funds effective rate. The federal funds target rate is determined by a meeting of the members of the Federal Open Market Committee which normally occurs eight times a year about seven weeks apart. The committee may also hold additional meetings and implement target rate changes outside of its normal schedule. The Federal Reserve uses open market operations to influence the supply of money in the U.S. economy to make the federal funds effective rate follow the federal funds target rate.
A measurement expressed as a percentage of the total amount of vacant space divided by the net square footage of the property.
This is a form of a Prepayment Penalty that requires the borrower to effectively guarantee to the lender the same yield as if the loan was not prepaid prior to maturity. It only comes into play if Interest Rates are lower than the current Interest Rate on the loan.