CRE Investing Glossary

A

Accredited Investor 

What is an accredited investor?

An accredited investor is an investor who meets the SEC requirements [1] for income or net worth including meeting one of the following criteria:  

• • Net worth over $1 million, excluding primary residence (individually or with spouse or partner) 
  • Income over $200,000 (individually) or $300,000 (with spouse or partner) in each of the prior two years, and reasonably expects the same for the current year

What does being an accredited investor allow you to do?

Most security offerings, private equity, hedge funds, and syndications only allow accredited investors to participate in their offerings. Categorizing accredited investors helps the SEC prevent inexperienced and uninformed investors from being taken advantage of and to protect those ill-equipped to handle greater financial risk.  

Accrued Interest 

What is accrued interest?  

Accrued interest is an accounting term denoting the amount of interest incurred, but yet to be paid, as of a specific date.

How is accrued interest used?  

Investors need to include accrued interest in their debt calculations to ensure they determine the correct cash flow after repayment.

Amortization 

What is amortization?  

Amortization is the process of spreading a cost, typically related to the repayment of a loan’s principal amount, into sequential payments over a set number of periods.

How is amortization used?  

Amortization is used by lenders to set a schedule of repayment. An amortized loan allows investors to pay off the loan principal over varying lengths of time. 

Asset Allocation  

What is asset allocation?  

Asset allocation encompasses the distribution of investment capital within a portfolio across various investments, strategies, sectors, or other methods of categorization. Asset allocation is often used to define the strategic or tactical approach investment managers take to accomplishing a portfolio’s given mandate in regard to risk, return, and diversification.

How is asset allocation used?  

Asset allocation is used by investment managers to diversify risk and return across the universe of investment options and strategies. 

C

Capital Call

What is a capital call?  

A capital call is a legally enforceable ask from a private equity entity to their limited partners (i.e., investors) for a portion or full amount of the committed capital to be transferred to the fund.  

How is a capital call used?

Fund managers regularly use capital calls to use on an as-needed basis to collect capital when an asset needs funding. Capital calls usually facilitate purchasing new investments or carrying out strategic project initiatives at specific assets.

Capital Expenditures (CAPEX) 

What are capital expenditures (CAPEX)?  

Capital expenditures (CAPEX) are the costs to renovate, upgrade, or repair an asset. 

How are capital expenditures (CAPEX) used?

Capital expenditures (CAPEX) are used by investment or operation managers to increase the long-term value of an asset. CAPEX is often capitalized and not categorized in the same manner as operating expenses on a balance sheet.

Capital Stack

What is a capital stack?  

The capital stack represents the types and distribution priority of capital used to finance a transaction. Typically the capital stack will be made up of debt and equity positions, with debt structures sitting in a higher priority position than equity classes.  

How is capital stack used?

The capital stack is an important point of reference to determine the priority in which distributions are returned to investors and financiers. The capital stack also displays the order of priority in which creditors and equity holders will be repaid in the event of liquidation.  

Capitalization Rate 

What is a capitalization rate?  

The capitalization rate or cap rate is a formula for dividing the property’s market value by the current operating expressed in a percentage.  

Net Operating Income / Asset Market Value = Cap Rate  

Here is an example:

If an investment property reports an annual NOI of $450,000 and it’s assumed market value is $6,000,000 then the property’s cap rate is 7.5%.

How is a capitalization rate used?

A cap rate is a metric to assess an investment property’s potential profitability and return before bringing in mortgage financing. In other words, investors use it to determine their potential initial yield.

Cash on Cash Return (COC)

What is a cash on cash return (COC)?

A cash on cash return is a ratio showing the total cash earned (before taxes) to the total capital invested.  

For example: 

 Annual Pre-Tax Cash Flow / Total Cash Invested into the Property = COC 

 An investor purchased a 20-door apartment complex for $2M with a downpayment of $400,000 and $10,000 in closing costs.  

The complex achieved a rental rate of $1,000/unit and maintained an 80% occupancy rate, earning $192,000 of annual rental revenue. The apartment complex is also earning $2,000 in parking fees and $1,000 from laundry services. 

Gross Revenue = ($192,000 + $2,000 + $1,000) = $195,000 

The annual property management fee is $9,000, the annual maintenance fees are $20,000 the annual insurance costs $5,000, the property pays $4,000 in property taxes, and the annual mortgage payment is $130,000.  

 Annual Cash Outflow: ($9,000 + $20,000 + $5,000 + $4,000 + $130,000) = 168,000  

 Annual Pre-tax Cashflow: $195,000 – $168,000 = $27,000 (annual cash inflow-annual cash outflow) 

 $27,000 / 410,000 = 6.59%* 

 *expected first year cash on cash return  

How is a cash on cash return used?

• Cash on cash returns are usually shown in percentages to determine the annual cash flow back to the investment entity.
• Investors often use COC as a metric to determine future cash yield potential.

Cash-Out Refinance

What is a cash-out refinance?  

A cash-out refinance is the process of restructuring a loan so a property owner can convert equity in the property into cash, effectively increasing the loan principal to be paid down.

How is a cash on cash return used?

Property owners use cash-out refinance for several reasons:  

• • to free up capital for new investment opportunities  
  • to reduce interest expenses  
  • to distribute capital to investors  
  • to renovate or expand the property  

D

Debt Service

What is debt service?  

Debt service is a property’s total payment on its debt obligations on a monthly or annual basis. Debt service can change over time if a loan has a variable rate or if there is an interest only (IO) period. 

How is debt service used?  

Debt service is used in several financial calculations to account for the cost of financing an asset.

Debt Service Coverage Ratio (DSCR)

What is a debt service coverage ratio (DSCR)?  

Debt service coverage ratio (DSCR) is a financial measurement of the property’s ability to generate cash flow to fund the cost of its debt obligations. DSCR is usually expressed as a multiple.  

NOI / Total Debt Service = DSCR  

How is a debt service coverage ratio (DSCR) used?

Lenders use the Debt Service Coverage Ratio to evaluate if an asset can support a specific debt load. Many lenders want to see a DSCR greater than 1.2x. If an asset’s profitability is not able to maintain a 1.2x DSCR, the Lender may reduce the amount of debt capital made available.

Depreciation

What is depreciation?  

Depreciation is an income tax deduction that allows commercial property owners to write off a portion of the property’s value each year to account for its physical deterioration and decrease in value.

How is depreciation used? 

Property owners use depreciation to offset rental income and reduce tax liability.

Discount Rate

What is a discount rate?  

The discount rate is the rate used to find the present value of future cash flows. 

How is a discount rate used?

Investors use the discount rate to determine the current value of an asset’s potential future cash flows. It often represents opportunity costs, inflation, and risk of ownership during the hold period. Investors use it to determine if a property will meet or exceed a targeted return over its lifetime of ownership.

E

Equity Multiple

What is an equity multiple? 

An equity multiple is a ratio showing the total cash distribution received divided by the total equity invested. 

Total Profit / Total Value of initial investment = Equity Multiple  

How is an equity multiple used?  

An equity multiple is used to evaluate the total earning power over the full lifecycle of an investment in relation to the amount of capital invested, without regard for the length of the investment period.  

 Here is an example:   

If an offering projects an equity multiple of 2.50x the investment would return $2.50 on every $1.00 invested for the full period of the investment (I.e., not on an annual basis).

Equity Value 

What is equity value?  

The Equity Value at an specific point in time can be determined by taking an asset’s market value and then deducting any debt or liabilities that would need to be paid off in the event of disposition.

How is equity value used?  

Equity value is used to determine an investor’s potential profit on the sale of a property as the delta between the equity capital used to acquire and operate the asset and the Equity Value at present represents the investor’s potential gain on sale.

Equity Waterfall

What is an equity waterfall?   

An equity waterfall is a structure outlining the process and priority for the return of capital and cash flow distributions on a project or a fund to all classes of equity investor in the deal. 

How are equity waterfalls used?  

Investment managers use equity waterfalls to explain to investors the priority and process for capital return and profit distribution.

I

Internal Rate of Return (IRR) 

What is internal rate of return (IRR)?  

Internal rate of return is financial metric, usually represented as a percentage, that uses the time value of money to compute the annualized rate of return for an asset over a specific period of investment. 

How internal rate of return (IRR) used?

IRR is used to determine an investment’s annual rate of return which can be particularly useful when cash inflows and outflows vary from period to period over the life of an investment. IRR allows investors to essentially smooth out the lumpiness in cash flows to understand the annual rate of return of a particular investment and to compare this return with other investments that may too have irregular cash flows.

K

K-1

What is a K-1?

A K-1 is a federal tax statement that reports each investor’s share of income, losses, deductions and credits in a fund or investment structure.

How does an investor use a K-1?

Investors use the information from their K-1 to file their tax returns.

L

Loan to Cost (LTC)  

What is loan to cost (LTC)? 

Loan to cost (LTC) is a ratio similar to LTV, but which incorporates the cost of construction and improvements in addition to asset value. LTC is typically used in place of LTV when financing is being sought to cover an amount and scope greater than solely the purchase of an asset. LTC is usually expressed as a percentage.  

Loan Amount / (Asset Purchase Price + Construction Costs) = Loan to Cost  

How is loan to cost (LTC) used?  

Loan to cost is used by Lenders to size debt financing for a project. Investors use the ratio to help determine the amount of equity needed for the acquisition and construction and/or improvement of an asset.

Loan to Value Ratio (LTV)

What is a loan to value ratio (LTV)?  

Loan to value ratio (LTV) is a metric measuring the magnitude of debt being used to finance an asset relative to the price of the asset.  

Loan Amount / Purchase Price of Asset = Loan to Value Ratio (LTV) 

How is a loan to value ratio (LTV) used?

Loan to value ratio is used by lending institutions to size their debt financing on an asset. Riskier assets will typically receive financing terms at lower LTV’s. Investment managers also use the ratio to determine the needed down payment for a property and to estimate the servicing and financing costs of the debt being considered. 

Letter of Intent (LOI)  

What is a letter of intent or LOI?  

A letter of intent or LOI is a non-binding document between a commercial real estate buyer and the seller outlining the terms in which they intend to transact. 

How is a letter of intent (LOI) used?

A letter of intent (LOI) is used by commercial real estate buyers to express their firm interest in purchasing a property. The document is not legally enforceable, and, in most cases, it only starts official negations between the two parties.  

Limited Partner (LP) 

What is a limited partner (LP)?

A limited partner (LP) is a passive investor who holds an equity interest in an investment vehicle. Whether the investment is a syndicated deal, a fund, or a Special Purpose Vehicle, the LP’s make up the non-managing equity partners in the transaction.

What do limited partners do?

The primary responsibility of a Limited Partner is to fund their capital commitment(s) in accordance with the process laid out in their investment documents. 

N

Net Operating Income (NOI)  

What is Net Operating Income (NOI)?  

Net Operating Income or NOI is the annual revenue a property generates after all operating expenses have been taken into account but before taxes (aside from property taxes) are subtracted.  

Property’s Gross Income – Operating Expenses = NOI  

Here is an example:  

 If an RV Park is generating $120,00 from seasonal bookings, $10,000 from nightly bookings, and $5,000 from its general store then the total annual revenue for the park would be $135,000. 

 $120,000 + $10,000 + $5,000 = 135,000 

 The park also has $2,000 of yearly maintenance costs, $15,000 of payroll expenses, $2,200 in property taxes, and $3,000 of insurance costs.  

 $2,000 + $15,000 + $2,200 + $3,000 = $22,200 

The RV park’s NOI would be: 

 $135,000 – $22,200 = 112,800  

How is Net Operating Income (NOI) used? 

NOI is used for a myriad of purposes: 

• Investors use NOI to determine the current value of the property and if the investment property could be profitable with future renovations, management expenses, and loan service  
• Lenders use NOI when calculating the debt coverage ratio (DCR) and determining their willingness to extend a loan for the project  
• Sellers use it as the main marker in their OM to show the profitability of their property during the sale 

Net Present Value (NPV) 

What is net present value (NPV)? 

Net Present Value is the result of calculations that compute the current value of a future stream of cash flows, using a proper discount rate. 

How is net present value (NPV) used?

As Net Present Value takes into account the magnitude and timing of cash flows along with the project’s appropriate discount rate for those future cash flows, it can be used to determine whether a project is worth undertaking.  

O

Opportunistic Deal 

What is an opportunistic deal?  

Opportunistic deals are those in which a portion of the risk and return profiles are defined by adverse or extenuating circumstances which hold the potential for upside if reconciled such as foreclosure, mismanagement, disrepair, death, etc. These deals are characterized by their higher degree of risk and need for effort and or experience to turn them around in order to achieve higher potential upside.  

How are opportunistic deals classified?

Opportunistic deals are classified as real estate projects with higher levels and/or unique risk but with the potential for significantly higher returns. Complicated return strategies, including heavy value-add, development, or repositioning, are signs of opportunistic deals. 

P

Pari Passu

What is pari passu?  

Pari passu is a term used by real estate and legal professions meaning “equal footing.”  

How is pari passu used?

In the real estate sector, pari passu clauses are usually used in waterfall structures to dictate that the investment partners will receive equal payouts proportionally to their initial investment until a return minimum has been reached. 

Personal Guarantee 

What is a personal guarantee?  

A personal guarantee is when a financier requires a personal commitment from the sponsor to be liable for a specified amount of the debt in case of default.  

How is a personal guarantee used?

Lenders often ask for a personal guarantee if they have any concerns about the sponsoring entity’s credit history, track record, or financial stability, or if the project to be financed is particularly risky. 

Preferred Equity 

What is preferred equity?  

Preferred equity is an equity investment with priority over common equity in the capital stack, typically considered less risky that other subordinate classes of equity, but more risky than debt. Preferred equity is often structured such that investors receive a fixed return at a rate higher than most debt in the capital stack, but without the upside potential of more risky common equity.  

How is preferred equity used?

Preferred equity is often used to fill debt funding gaps in the capital stack and as a means to attract capital from risk-averse investors willing to forego upside participation for downside protection and distribution priority over common equity holders.

Preferred Return 

What is a preferred return?  

A preferred return is a profit distribution structure in which a minimum return must be distributed before the sponsor can collect a performance fee. 

How is a preferred return used? 

Private equity groups often use preferred return structures to create a high level of confidence in the investment and to be incentivized to make the investment as high-yielding as possible to ensure a sponsor return.

Private Placement Memorandum (PPM)  

What is a private placement memorandum (PPM)?  

A private placement memorandum (PPM) is a legal document that highlights the term and conditions of a real estate offering.  

How is a private placement memorandum (PPM) used?

A private placement memorandum (PPM) is given to a potential real estate investor to review the structure, projected returns, terms, and risks of an offering before investing. 

Pro Forma

What is a pro forma?  

A pro forma is a financial statement that documents a property’s key financial metrics, including but not limited to NOI, cash flows, operating expenses, improvement costs, and rental rates. 

How is a proforma used?

A pro forma is used by investors to project potential future profit on an asset. Investors use the specified assumptions and financial metrics to forecast how changes in assumptions affect financial performance. 

Purchase & Sale Agreement (PSA) 

What is a purchase and sale agreement (PSA)?  

A purchase and sale agreement or PSA is a legally binding statement that includes the terms and conditions in which a buyer and seller will transact. The PSA also spells out courses of remedy and remediation if the transaction runs afoul. 

When is a purchase and sale agreement (PSA) used?

A purchase and sale agreement is a contract to bring the seller and buyer of a commercial property to an agreement on the terms of a property sale. It usually defines terms including the sale price, title information, due diligence period, escrow period, warranties, and any contingencies. 

R

Real Estate Investment Trust (REIT)

What is a real estate investment trust (REIT)?  

A real estate investment trust or REIT is a company that owns, operates, or finances a diverse set of income-producing real estate across various property sectors. Most REITs are registered with the SEC and are publicly traded on an exchange. REITs operate much like mutual funds but are subject to strict guidelines such as a) the requirement to derive at least 75% of gross income from rents, mortgage interest, or real estate sales proceeds b) REITS must pay at least 90% of their taxable income in the form of shareholder dividends each year c) must have at least 100 shareholders after its year of inception  

What do real estate investment trusts or REITs allow investors to do?

Real estate investment trusts or REITs allow individual investors to invest in real estate by purchasing shares which give them exposure to a diverse portfolio of real assets. REITs enable individual investors to invest in real estate with the added benefits of liquidity and diversification, however, REITs may trade below their NAV and do not pass many of real estate ownership’s tax advantages on to investors. 

Real Estate Syndication 

What is a real estate syndication?  

A real estate syndication is a deal in which a sponsor funds a single project by raising capital from multiple investors.

Return on Investment (ROI)  

What is Return on Investment (ROI)?  

Return on Investment (ROI) is the net value of returns produced by an investment divided by its cost, usually expressed as a percentage.  

ROI = Net Return of Investment / Total Cost of Investment 

Here is an example:  

An investor buys a property valued at $500,000. They pay a $100,000 down payment and $5,000 in closing costs. They also pay $12,000 for upgrades and renovations.  

Their monthly mortgage payment is $1,900 or $22,800 annually 

The investor rents the property for $3,000 a month or $36,000 a year. They spend $1,000 on insurance costs and $500 on maintenance costs annually.  

The property’s net return for the year would be:  

$36,000 – ($22,800 + $1,000 + $500) = $11,700  

The property’s ROI would be: 

$11,700/ $117,000 = 10% 

How is Return on Investment (ROI) used?

ROI is used as a metric for evaluating an investment’s ability to produce returns in relation to the capital allocated to the investment. 

Risk-Adjusted Return

What is a risk-adjusted return? 

Risk-adjusted return is a measure of profit or potential profit that takes into consideration the risk inherent in achieving such a return.   

How is a risk-adjusted return used? 

Risk-adjusted return is used by investment managers to evaluate an investment’s return or potential return in the context of the risk incurred in achieving that return. In this manner an investment manager can compare investments with different risk profiles in order to determine which produces the best return per unit of risk assumed. 

S

Stabilization

What is stabilization?  

Stabilization typically occurs when a property achieves a consistent and sustainable level of occupancy, expenses, and revenue following either construction or significant renovation. Once a property is built and receives its Certificate of Occupancy, it may take months or years for units to be leased up and for operations to normalize, at which point it would be considered stabilized.

How is stabilization used?

Stabilization periods are used by investment managers account for and anticipate the time it will take a property to achieve target occupancy following construction or renovation. Buyers use a pro forma based on stabilized periods to determine acquisition prices and lenders use it to set loan parameters. A typical stabilization period includes when a property has achieved 80% occupancy for a full calendar quarter.  

T

Total Returns on Equity

What is total returns on equity?  

Total returns on equity is the total return on investment, including cash flow and appreciation on the initial capital that is distributed to equity investors after debt and other liabilities are covered. 

How is total returns on equity used?

Investment managers use total returns on equity to compute various performance metrics specific to equity positions in the capital stack.

V

Value-Add Deal

What is a value-add deal?  

A value-add deal is an investment opportunity that aims to increase profitability through capital improvements and the creation of other income drivers. Value-add deals typically aim to expand a property and/or to reposition a property. 

What are common value-add strategies?

Common value-add strategies include but are not limited to expansion, upgrading amenities, interior and exterior renovations, outsourcing management, renegotiating contracts, and developing other income drivers. 

[1]https://www.sec.gov/education/capitalraising/building-blocks/accredited-investor