Absorption Rate: The rate at which available properties are sold in a specific real estate market during a given time period. It is calculated by taking the number of homes that sold in a month and dividing it by the total number of homes for sale at the end of the month.
Adjusted Basis: The net cost of an asset after adjusting for various tax-related items. It is calculated by taking the original cost basis of a property and then adding any capital improvements and subtracting any total accumulated costs, recovery deductions, and partial sales taken during the holding period.
Amortization: The repayment of debt or loan principal through equal payments over a designated period of time that covers both the principal and the interest. With each mortgage payment, a portion of the payment is applied towards reducing the principal and another portion of the payment is applied toward the 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 charged for borrowing a loan expressed as a single percentage number that reflects the actual yearly cost of the funds over the term of the loan. The APR reflects not only the interest rate, but also all charges made to the borrower, including compound interest, discount points, commitment fees, and mortgage insurance premiums. It also takes into account the time at which the principal is repaid. For this reason, your APR is usually higher than your interest rate.
Appreciation Potential: The possibility or probability that a real estate investment will increase in value during the holding period
Assessed Value: The dollar value assigned to a property by the tax assessor for purposes of measuring applicable taxes.
Average Annual Effective Rate: The average annual effective rent divided by the square footage
Averaging Method: A technique used to forecast next period’s/year’s vacancy rate by averaging the previous years’ vacancy rates. This is especially effective where vacancy rates have remained relatively flat or show little variability over time.
Balloon Payment: The final payment of the balance due on a partially amortized loan
Basis: The total amount paid for a property including equity capital and the amount of debt.
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 - these items are added to the basis of the property and then can be depreciated over the holding period. Capital Expenditures are different from cash outflows for expense items such as new paint or plumbing repairs which are operating expenses. Also see operating expenses.
Capital Gain: Profit that results from the sale of a capital asset where the sale price exceeds the purchase price
Capitalization Rate: Also referred to as cap rate. The rate of return on a real estate investment property based on income the property is expected to generate over time. It is used to estimate an investor’s potential return on his/her investment. It can be calculated by taking net operating income and dividing it by the purchase price.
Capital Tax: Any tax on a change in capital value (including capital gains tax, estate tax, or inheritance tax) as opposed to tax on income
Cash Flow: In real estate investing, cash flow is the difference between all of the cash inflows and outflows. It is calculated by taking all of the money flowing in from the property (such as rental and other income) and subtracting the money that flowed out over the course of the holding period (such as operating expenses, debt payment, capital additions, etc.) Cash flow helps determine the viability of a property.
Cash Flow After Taxes (CFAT): CFAT is the amount of money generated by a property minus tax liability. CFAT represents the actual revenue a property generates that an investor gets to keep. Once Cash Flow Before Taxes (CFBT) is calculated, simply subtract tax liability to find Cash Flow After Taxes (CFAT).
Or another method:
CFAT = Net Income Depreciation Amortization Other Non-Cash Charges
Cash Flow Before Taxes (CFBT): CFBT is the Net Operating Income minus debt service and other expenses, but not tax liability. CFBT represents cash that would be available to pay off creditors in the event of liquidation.
Begin with Net Operating Income then substract debt services
Cash-On-Cash Rate: Calculates income earned from the cash invested into a property. It is calculated as follows:
Cash-on-Cash Rate = annual cash flow before taxes/total cash invested
Cash Proceeds From Sale: The sales price minus sales costs, outstanding mortgage balance, and tax liability on sale. Also referred to as sales proceeds after tax.
Commercial Real Estate: Commercial Real Estate is any property used to make profit by leasing out space. This includes any multifamily, office, industrial, or retail property that can be bought or sold in a real estate market.
Cost Approach: The Cost Approach is one of three valuation methods used in real estate appraisal. The basic tenet of Cost Approach valuation holds that the price a buyer pays for a property should be equal to the cost to build an equivalent building.
Using the cost approach appraisal method, the market price of the property is equal to the cost of land plus cost of construction, minus depreciation. This appraisal approach is the most effective when the property is new.
Debt-Service Coverage Ratio (DSCR): The Debt-Service Coverage Ratio is a key part of determining the maximum loan amount for a commercial real estate loan. The DSCR is calculated by dividing Net Operating Income by Total Debt Service:
Debt-Service Coverage Ratio = Net Operating Income / Total Debt Service
If the DSCR is greater than 1.0 that means that there is enough cashflow to cover debt service. A DSCR lower than 1.0 means that there is not enough. Typically a lender will require a DSCR of more than 1.0.
Demographics: Statistical data that describes and organizes a population into groups and subgroups and by size, structure, and distribution.
Depreciation: Depreciation is the process used to deduct the costs of buying and improving a rental property across the useful life of the property. The IRS has specific rules that govern rental property depreciation, so be sure to know how this process works.
Discounting: Reducing the value of money that will be received in the future to reflect the opportunity cost of waiting to receive the money.
Due Diligence: Due diligence involves inspecting the property, reviewing related documents, and examining procedures conducted by/for a potential lender or purchaser in order to reduce risk. Performing due diligence should indicate potential issues and additional costs and help the purchaser decide whether or not the property is a safe or profitable investment.
Exchange: Under section 1031 of the Internal Revenue Code, a taxpayer may defer capital gains and related Federal income tax liability on the exchange of like-kind property. This means that when an investment property is sold, as long as the same type of property is purchased with the profit gained by the sale of the first property, real estate investors can avoid incurring the tax liability.
Expected Value (EV): The Expected Value is the anticipated value for a given estimate based on the sum of weighted averages of all possible outcomes of a probability distribution. The sum of each possible value multiplied by its probability of occurrence equals the Expected Value of the outcome.
EVs can be calculated for net operating incomes, after-tax cash flows, and rate of return.
Feasibility Analysis: Owners, investors, and developers each have their own objectives when beginning a real estate project. A feasibility study evaluates a proposed project to determine if that project will satisfy those objectives.
Financial Leverage: Leverage is an investment strategy that uses borrowed capital to increase the potential return on an investment
Fixed Expenses: A fixed cost is one that does not change in relation to building occupancy. This includes property taxes, insurance, some building maintenance, depreciation, etc.
Forecast: An estimate or prediction of a future condition or outcome
Forecast Period: An upcoming time period of interest in which a forecast is to be made
Fully Amortized Mortgage Loan: A loan that is paid back over time in installments so that the loan is fully paid off by the end of a set term.
Future Value (FV): The future value is the value of an asset at a specific date in the future assuming a certain interest rate.
Gap Analysis: A gap analysis evaluates the difference between demand and supply of a certain square footage of space for a specific type of commercial property in a particular market area. Gaps are expressed as the number of square footage demanded minus the amount of square footage available in a given time period.
If demand exceeds supply, the gap will be positive. A positive gap indicates that potential opportunities exist for commercial real estate transactions.
Gross Operating Income: One of the primary goals for a successful real estate investment is to generate positive cash flow every month. Gross Operating Income is a calculation that tells you the total income generated by the operations of a property before operating expenses are paid.
GPI is calculated by taking potential rental income plus other income affected by vacancy and subtracting vacancy and credit losses before adding income not affected by vacancy.
Gross Rent Multiplier (GRM): A method that real estate investors can use to determine market value presented as the ratio of the price of a real estate investment to its annual rental income before accounting for expenses.
The GRM is calculated by using the gross rents an investor expects a property will produce by the end of the first year multiplied by a given factor (called the Gross Rent Multiplier that is taken from the marketplace).
Household: A unit of housing measurement that reflects the number of households in a given geographic market or submarket as defined by certain characteristics such as demographic or socio-economic information.
Household Population: The total number of households in a given geographic market or submarket as defined by specific demographic and socio-economic characteristics
Housing Demand: The total number of housing units demanded in a given market, defined as occupied household units divided by one minus the vacancy allowance for that market (where demand is affected by the rate at which new households are being added to the market, allowing for a normal level of vacancy.
Income Capitalization Approach: 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. Value = net operating income / capitalization rate
Initial Investment: The outlay of cash needed to acquire an investment
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 equal the initial capital investment
Inventory: The supply or stock of a given commodity or a listing thereof
Investing: Limiting current consumption in favor of future consumption
Investment Value: The value to a specific investor, based on that investor’s requirements, tax rate, or financing
Lease: A contact that creates the relationship of landlord and tenant. A contractually binding agreement that grants a right to exclusive possession or use of property, usually in return for a periodic payment called rent.
Leasing: A means of obtaining the physical and partial economic use of a property for a specified period without obtaining an ownership interest
Leverage: The use of borrowed funds to finance a portion of the cost of an investment
Liquidity: The ability to convert an investment into cash quickly without loss of principal
Loan Balance: The amount of money remaining to be paid on an amortizing loan at a given time
Loan or Mortgage Value: That portion of the value of real property recognized by the lender when used to secure a loan
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
Management: The ability to monitor the performance of an investment and make changes as needed
Managing Risk: The steps taken by an investor or manager to control or reduce investment risk
Market Area: A geographical area in which supply and demand operate to influence the course of industrial and commercial activities, for example, a Metropolitan Statistical Area (MSA)
Market Adjustments: A change in market parameters or conditions brought about in response to one or more market signals (including price changes from shifts in supply and demand); typically characterized as cycles, fluctuations, or trends (categories that differ in terms of cause, duration, and impact on commercial real estate markets)
Market Analysis: The process of examining market supply and demand conditions, demographic characteristics, and opportunities; identifying alternative locations/sites that meet specific objectives or satisfy various criteria; and assessing the financial feasibility of those locations/sites to facilitate decision making regarding the commercial potential or suitability of various locations/sites to support a given activity or use
Market Data Approach: A method of determining the property’s value by analyzing recent sales or rental prices of comparable properties
Market Opportunities: Advantageous circumstances in a market which facilitate a given action or outcome that is generally viewed as favorable from a money-making standpoint
Market Pricing: The pricing of commodities (including rental rates of various types of commercial properties) as determined by the forces and factors of influence operating in a market
Market Strategy: A course of action defined with respect to a particular real estate market phase. For example, consider the market strategy of avoiding real estate transactions when there is an oversupply of space available in the market
Market Value: The most probable price that a property would bring in a competitive and open market under fair sale conditions
Multifamily Housing: Housing units that accommodate more than one family or household
Net Operating Income (NOI): The potential rental income plus other income, less vacancy, credit losses, and operating expenses
Operating Expenses: 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 account expenses. Operating expenses do not include capital expenditures, debt service, or cost recovery
Partially Amortized Mortgage Loan: The payments do not repay the loan over its term and thus a lump sum (balloon) is required to pay the loan
Population Growth: The rate at which a given population base in a given geographic area is growing (positive or negative) in relation to the forces of internal growth, in-migration, and out-migration; a factor that is widely acknowledged as having the greatest impact on the demand for housing
Population Migration: The movement and relocation of people from one place of residence to another in response to social and economic factors and forces; a long-term trend that can be expected to affect local economies and real estate values
Potential Rental Income: The total amount of rental income for a property if it were 100 percent occupied and rented at competitive market rates
Rate of Return: The percentage return on each dollar invested. Also known as yield.
Real Estate Cycles (Phases): The regularly repeating sequence of economic downturns and upturns and associated changes in real estate market transactions tied to market dynamics and changing macroeconomic conditions, whose phases include (in order) recession, recovery, expansion, and oversupply
Real Estate Fluctuations: Short-term variations in real estate prices or rents (usually lasting anywhere from one day to a few months) caused by natural hazards (such as tornadoes, hurricanes, floods, earthquakes, and wildfires) or boosts or shocks to the local economy (such as the entry or exit of major employers)
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
Real Estate Trends: Long-term movements or tendencies in the demand for commercial real estate (which can typically last for years or decades), usually tied to macroeconomic or business cycles
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
Recovery: A period of increasing economic activity or a general economic upturn, typically following a stabilization of key sectors and industries, marked by increasing sales and recovering prices in real estate markets as a direct result of an external shock (for example, a favorable tax code revision) or an increase in demand for commercial real estate which, in turn, leads to the absorption of excess space. Little or no construction occurs during the initial stages of this phase until most of the excess space is absorbed or until reasonable financing opportunities become available
Residential Property: Single- or multifamily housing units that are used, serve, or are designed as a place of residence
Risk: The probability that actual cash flows from an investment will vary from the forecasted cash flows
Sale Cost: The brokerage commissions and fees, and any additional transaction costs that are incurred during the sale of the property
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
Sales Proceeds After Tax: The sale proceeds before tax minus the tax liability on the sale
Sale(s) Proceeds Before Tax: The sale price minus the sale costs and the mortgage loan balance
Sales Comparison Approach: A way to determine market value by comparing a subject property to properties with the same or similar characteristics
Sales Comparison Value: An estimate of value derived by comparing the property being appraised to similar properties that have been sold recently, applying appropriate units of comparison, and making adjustments to the sales prices of the comparable based on the elements of comparison
Sinking Fund: A fund designed to accumulate a designated amount of money over a specified period of time. The periodic amount of money deposited plus compound interest will accumulate to the designated amount of money over the specified period of time
Submarket: A segment or portion of a larger geographic market defined and identified on the basis of one or more attributes that distinguish it from other submarkets or locations
Target Market: Likely users or investors whose needs match the property’s features. Alternatively when representing users, the target market is the kind of property that matches your user-client’s needs
Tax Liability: Real estate taxable income multiplied by the tax rate
Tax Shelter: The ability of real estate investments to reduce an investor’s tax liability through the use of cost recovery
Taxable Income: Adjusted gross income less personal deductions and exemptions
Tenant: A person or entity who has possession of the property through a lease. A tenant also may be referred to as a lessee
Time Value of Money (TVM): An economic principle recognizing that a dollar today has greater value than a dollar in the future because of its earning power
Total Employment: The total number of actively employed people in the workforce within a given geographic area at a particular point in time
Vacancy: The number of units or space (of a specific commercial type) that are vacant and available for occupancy at a particular point in time within a given market (usually expressed as a vacancy rate)
Vacancy Allowance: A desirable level of vacancy that is known to facilitate transactions and turnover in a housing market (for example, a vacancy rate that allows the market to operate smoothly and efficiently by enhancing household mobility); an index used for estimating housing demand
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