All the terms you need to know.
Absorption. The amount of inventory or units of a specific commercial property type that become occupied during a specific time period (usually a year) in a given market, typically reported as the absorption rate.
Add-on Factor. Calculated by dividing rentable square feet by useable square feet, the add-on factor can be used to evaluate different sites with comparable rents. Also known as load-factor or rentable-to-useable ratio. Contrast with efficiency percentage.
Adjusted Basis. The original cost basis of a property plus capital improvements, less total accumulated cost-recovery deduction and partial sales taken during the holding period.
Amortized Loan. A loan that is repaid in a series of installments each of which contains a portion that is applied to reduce the principal amount of the loan and a portion that is applied to pay interest. As time goes on, each successive payment allocates a larger portion to principal reduction and a smaller portion to interest payment until the outstanding balance is ultimately reduced to zero. If the loan has a fixed rate of interest, each payment is the same dollar amount throughout the course of the loan. If the loan has an adjustable rate of interest, each payment at each particular interest rate is the same dollar amount. For example, while the interest is 8.0%, all of the payments on a $100,000 loan for 30 years will be $733.77. If the interest rate changes to 9.0%, all of the payments will be $804.62 while the rate remains at the 9.0% rate.
Annual Debt Service (ADS). The total amount of principal and interest to be paid each year to satisfy the obligations of a loan contract.
Annual Percentage Rate (APR). The true annual interest rate payable for a loan in one year taking into account all charges made to the borrower, including compound interest, discount points, commitment fees, and mortgage insurance premiums. APR also takes into account the time at which the principal is repaid (particularly payments of principal made in installments throughout the year, when interest is charged at the beginning of the year), but not the actual expenses the lender incurs in making the loan that are recharged to the borrower.
Appraised Value. There are several types of appraisals depending on the goal. Values needed for multi-unit and commercial real estate are primarily based on the net operating income (or the potential net operating income) of the property. The appraised value of a property is an estimate of the market value at a given point in time and is typically performed by a licensed, independent real estate appraiser. (See the definition of net operating income below).
Average Annual Effective Rate. The average annual effective rent divided by the total square feet.
Average Annual Effective Rent. The tenant’s total effective rent divided by the lease term.
Balance. The outstanding dollar amount owed on a loan. Also referred to as loan balance or mortgage balance.
Balloon Payment. An installment payment which is larger (most often much larger) than the other scheduled payments. It is usually the last payment. If a note is written for $50,000 at a fixed 9.0% rate of interest with payments based on an amortization schedule of 30 years and a balloon payment due in 5 years, the first 60 payments will each be $402.31 (the normal payment for a 30 year loan at 9.0% interest) and the last payment will be $47,940.15 which will be the outstanding balance remaining after the 60th payment.
CAM. Common area maintenance.
Cap Rate. Capitalization rate.
Capitalization Rate. A percentage that relates the value of an income-producing property to its future income, expressed as net operating income divided by purchase price. Also known as cap rate.
Cash Flow. The net operating income minus the total of all debt service payments. (See definition of “net operating income” below.)
CCIM. A CCIM (Certified Commercial Investment Member) is a recognized expert in the commercial and investment real estate industry. The CCIM lapel pin is earned after successfully completing a designation process that ensures CCIMs are proficient not only in theory, but also in practice. This elite corps of CCIMs includes brokers, leasing professionals, investment counselors, asset managers, appraisers, corporate real estate executives, property managers, developers, institutional investors, commercial lenders, attorneys, bankers, and other allied professionals.
Closing. The formal meeting where loan documents are signed and funds disbursed.
Closing Costs. The expenses which borrowers incur to complete the loan transaction. These costs may include title searches, title insurance, closing fees, recording fees, processing fees and other charges.
Deed of Trust (DOT). DOTs are similar to mortgages in that they serve as security for a loan by encumbering real estate. However, a mortgage is between two parties (borrower and lender) and a deed of trust involves three parties (borrower, lender and trustee). The trustee holds the property in trust as security for the payment of the debt and can sell the property if the borrower defaults.
Default. Failure to meet all of the commitments and obligations specified in the mortgage or deed of trust. Defaults usually give the lender the right to accelerate payments and start foreclosure.
Discount Rate. The percentage rate at which money or cash flows are discounted. The discount rate reflects both the market risk-free rate of interest and a risk premium.
Escrow Account. An account from which funds can be disbursed only for specified reasons; i.e. the money is held in trust for a specific use. In lending, these accounts are most often used to hold and disburse real estate taxes and hazard insurance premiums which have been paid in advance (usually on a monthly basis) by the borrower.
Fiduciary Responsibility. An obligation to act in the best interest of another party. This type of obligation typically exists when one person places special trust and confidence in another person and that responsibility is accepted.
First Mortgage. That mortgage which is recorded at the earliest time. The time of recording is the sole criteria. Size of loan and type of mortgage are immaterial. When the first mortgage is paid off and released, the second mortgage (if any existed) becomes the first mortgage.
Foreclosure. The process by which the mortgagor’s (borrower’s) rights to a property are terminated. While the general process is similar from state to state, the actual procedures tend to vary greatly.
Hard Money Loan. A loan that is underwritten with the condition and value of the property as the primary criteria for approval. Secondary issues may include the credit of the borrower, the ability of the borrower to repay the loan and/or the ability of the borrower to manage the property or successfully complete a rehab and sell the property. Owner occupancy, debt ratios and other issues are seldom a factor. Appraisals rather than purchase prices are used to determine value. Cash out purchases are often allowed and are another key benefit. These loans are usually approved within days and are often funded in two weeks or less. Times as short as two or three days are not uncommon. The cost for the benefits of speed of funding and other advantages is typically a moderately high interest rate (usually low to mid teens) and high points (usually 5 to 10). (See definition of ” underwriting” below.)
Hazard Insurance. Insurance to provide compensation if the improvements are damaged or destroyed. It is almost always a requirement of loans.
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.
Interest Rate. The percentage of the loan amount charged for borrowing money; i.e., the cost of the money expressed as a percentage.
Land Sale-Leaseback. The same concept as a sale-leaseback, but only the land is sold and leased back using a ground lease.
Lien. A claim on a property of another as security for money owed. Examples of types of liens would include judgments, mechanic’s liens, mortgages and unpaid taxes.
Loan-to-Value (LTV). The ratio of the size of the loan to the value of the property. If the loan is $80,000 and the value of the property is $100,000 the LTV is 80% ($80,000 / $100,000).
Loan Package. The organized group of documents that contains all of the information required to obtain an underwriting decision of loan approval or loan denial. Depending on the type of loan and the particular lender, a package may contain some or all of the following as well as other documents: loan application, statement of use of funds, statement of net worth, P & L statements, tax returns, pay stubs, statements from various types of banking and investment accounts, property appraisal, letters of explanation, credit report, verification of employment, verification of housing payments, purchase agreement, etc. (See definition of “underwriting” below.)
Mortgage. A lien against real property given by a borrower to a lender as security for money borrowed.
Mortgagee. The entity to whom the mortgage is given; i.e., the lender.
Mortgage Loan. A loan which is secured by a mortgage lien filed against real property.
Mortgagor. The entity who gives the mortgage; i.e., the borrower.
Net Operating Income (NOI). From income producing property, the gross income minus the total of all expenses except for debt service. Cash flow is defined as NOI minus the total of all debt service payments.
Note. A written promise to repay a certain sum of money on specified terms.
Origination Fee. A fee paid to either a broker or a lender for originating a loan. It may be the only compensation for their work in arranging and/or processing the loan or it may be only a portion of the compensation. Not every loan has an origination fee.
Originator. An individual who works with a borrower to start a loan. Usually an employee of a financial institution, an employee of a broker or an independent contractor affiliated with several brokers. The originator determines the type of loan a borrower probably qualifies for, helps complete an accurate application, gathers documents necessary to get an approval and acts as an intermediary between the borrower and the underwriter.
Partially Amortized Mortgage Loan. A loan in which the payments do not repay the loan over its term, so a lump sum (balloon) is required to repay the loan at the end of the term.
Points. Charges prepaid by the borrower upon origination of a loan. One point equals 1 percent of the loan amount. Also known as loan points.
Positive Leverage. An investment situation in which borrowed funds are invested at a rate of return higher than the cost of the funds to the borrower.
Prepayment Penalty. A fee charged for paying off a loan within a relatively short period of time after the loan has closed. This provision is currently found only in non-conforming products. The time period during which it applies is usually one to three years and the amount of the penalty is usually 1.0% – 3.0% of the original loan amount though other, more complicated formulas are sometimes used. These provisions are sometimes regulated by state law. If a $50,000, 15 year loan were paid off in six months on a loan that had a 1.0% prepayment penalty, the penalty would be $500 ($50,000 x 0.01).
Principal. The amount being borrowed.
Rate of Return. A gauge of the percentage return on each dollar invested. See yield.
Refinance. The process of a borrower paying off one loan with the proceeds from another.
Reversion Value. A lump-sum cash benefit that an investor receives or expects to receive upon the sale of an investment.
Risk. The probability that actual cash flows from an investment will vary from the forecasted cash flows.
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.
Scale Economics. Cost reductions, savings, or advantages that come about from efficiency gains associated with increasing levels of production output or the increased size of an operation or system (as the average cost of production falls with increasing output or size).
Second Mortgage. That mortgage which is recorded after one other mortgage has already been recorded (and has not yet been released). When the first mortgage is paid off and released, the second mortgage becomes the first mortgage.
Securitization. The phenomenon of indirectly investing in real estate markets in ways that minimize risk (for example, investments made collectively with pooled money or the use of investment packages/funds, such as mortgage backed securities sold on the secondary financial market) as opposed to direct investments where investors own property or hold mortgages.
Statement of Net Worth. A document which contains in an organized fashion all of the financial assets and liabilities of an individual or other entity.
Subordination. An agreement to let an inferior lien (one filed later in time) take precedence (be considered as if it were in a superior position). It is not uncommon for a lender considering a loan request for a large mortgage (particularly one that will refinance a first mortgage) to require that a second mortgage already in place remain, in effect, in second position through the use of a subordination agreement.
Term. The length of time for which money can be borrowed.
Underwriting. The act of applying formal guidelines that provide qualitative and quantitative standards for determining whether or not a loan should be approved.
Weighted Average Cost of Capital (WACC). The average cost of capital (whether equity or debt), that considers the relative proportions of each capital source.
Yield. Return on investment (the rate at which an investment pays interest and/or dividends).
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.