Investment Real Estate Finance & Asset Management Terms

Financial Institution Reform, Recovery, and Enforcement Act

A U.S. federal law enacted on August 9, 1989 in the wake of the savings and loan crisis of the 1980s. It established the Resolution Trust Corporation (RTC) to close hundreds of insolvent thrifts and provided funds to pay out insurance to their depositors. It transferred thrift regulatory authority from the Federal Home Loan Bank Board to the Office of Thrift Supervision, and dramatically changed the savings and loan industry and its federal regulation to encourage loan origination.

Chart of accounts

A classification or arrangement of account items by type of income or expense (e.g., rent, advertising, insurance, maintenance), as well as assets and liabilities, accounts receivable, and accounts payable.

Adjustment

A component of the real estate cycle. A period when demand declines, occupancy diminishes, and rent concessions become widespread, usually in conjunction with a period of recession or depression. In accounting, modification of account records to reflect actual conditions at the close of a given period (e.g., by adjustment of journal records for accruals, corrections, and depreciation). In employment, an increase (or decrease) of an individual's wages or salary. In insurance, agreement on the amount to be paid to the insured.

Functional obsolescence

A condition of obsolete design or use of a property. Defects in a building or structure that detract from its value or marketability. Such defects may be curable or incurable.

Fidelity bond

A contract issued by a third party (usually an insurance company) that protects one individual against financial loss that might result from dishonest acts of another specific individual. A bond obtained by an employer to protect against the loss of money or property sustained because of the dishonesty of an employee.

Foreclose / foreclosure

A court action initiated by the mortgagee, or a lienor, for the purpose of having the court order the debtor's real estate sold to pay the mortgage or lien (e.g., a mechanic's lien or court judgment).

Debt investment

A form of real estate investment where funds are loaned to property owners in exchange for a payment of interest (i.e., lender).

Explanation of accounts

A guide or legend that details which category to use for each instance of cash inflow, cash outflow, and expense accrual. Sometimes referred to as manual of accounts.

Debt coverage ratio (DCR)

A lender's ratio that compares the annual net operating income (NOI) to the annual debt service of the loan and expresses the ability of the property to pay back the loan. The formula is: NOI ÷ ADS = DCR.

Anchor

A major shopping center tenant that will draw the majority of customers to the site. Normally an anchor tenant occupies a large space in a desirable location in the shopping center. Often there are two or more anchor tenants, depending on the type of center.

Cost approach

A method of appraising real property in which the value of the improvements is estimated on the basis of the cost to reproduce them minus accrued depreciation; also called summation approach.

Discounted cash flow (DCF) analysis/method

A method of valuation that discounts all future fiscal benefits of an investment property over a predetermined holding period. See also appraisal.

Financial management rate of return (FMRR)

A method that relies on investor selected rates of return in calculating positive cash flow as a basis for decision-making. FMRR varies from internal rate of return (IRR) with regard to reinvestment rates and tends to project a more market-driven return.

Balanced portfolio

A portfolio consisting of a variety of properties and risk levels, the intent being that the "safe" investments will provide returns only as expected and some of the higher-risk items will be more financially successful, resulting in a higher overall return for the portfolio.

Free-and-clear rate of return

A ratio that measures the return potential of a property that is free of debt, compares net operating income (NOI) with the total property value. The formula is: NOI ÷ Property Value = Free-and-Clear Rate of Return. Front office: The real-time accounting functions that require interaction with tenants or residents, including lease administration and enforcement and rent collection.

Equity REIT

A real estate investment trust that owns or has an equity interest in rental real estate (rather than making loans secured by real estate collateral).

Discount

A reduction in price, usually as a reward for paying a charge prior to the date of delinquency or for buying in quantity.

Capitalization rate

A single rate that converts a single year's income into value. It is the rate of return to estimate the property's value. The capitalization rate formula is: Net Operating Income (NOI) ÷ Property Value (or sales price).

Balance sheet

A statement of the financial position of a person or a business (or investment property) at a particular time, indicating assets, liabilities, and owner equity.

Financial accounting

A system of classifying financial transactions that documents a company's financial position in the form of a balance sheet and an income statement (external reports).

Cost recovery

A tax deduction allowed by the Internal Revenue Service to recover the cost of a depreciable asset.

Annual budget

A twelve-month estimate of income and expenses for a property.

Consumer Price Index (CPI)

A way of measuring consumer purchasing power by comparing the current costs of goods and services to those of a selected base period; formerly cost-of-living index. Sometimes used as a reference point for rent escalations in commercial leases (i.e., as a measure of inflation). The CPI is published monthly by the U.S. Department of Labor, Bureau of Labor Statistics.

Adjusted funds from operations (AFFO)

AFFO is equivalent to funds from operations (FFO) less an allowance for maintenance capital expenditures and leasing costs to reflect the cash a REIT spends to maintain its buildings. (See funds from operations.)

Back office

Accounting functions that do not require interaction with tenants. These may include preparation of historical operating data after an accounting period is closed, payment of operating expenses for properties, and operation of the management company.

Defeasance

Act of using substitute collateral to satisfy a borrower's loan and allowing a property to then be sold or refinanced. This is typically achieved by using government-backed securities to substitute for the cash flow that the original loan guaranteed. Defeasance does not prepay the loan; rather, it substitutes a specific set of securities that produce the same income over the same time frame. Default: Failure to fulfill an obligation (as a mortgage or other contracted payment) when it is due. The nonperformance of a duty, such as those required in a lease or other contract. Sometimes called breach of contract. Deferred maintenance: Ordinary maintenance of a building that, because it has not been performed, negatively affects the use, occupancy, and value of the property. Also, an amount needed for repairs, restoration, or rehabilitation of an asset (e.g., real property) but not yet expended. Delinquency report: Failure to make payment on a debt or obligation when due. A report that states being overdue. A debt on which payment is in arrears, as of mortgage principal or interest or rent under a lease. Deposit account: One of two types of accounts frequently kept for each client in a property. Specifically, a deposit account is an interest-bearing account frequently used as a repository for all income. Depreciation: Loss of value. In real estate, decline in value of a property resulting from physical deterioration (ordinary wear and tear), functional obsolescence (out-of-date systems and/or equipment), and/or economic obsolescence (market changes). See also obsolescence. In accounting, the gradual process of converting a fixed asset into an expense. Also, the tax deduction that allows for recovery of the investment in certain types of property by allocation of the cost over the estimated useful life of the property; also called cost recovery. In real estate, depreciation (and cost recovery) applies to the cost of improvements to land; the land itself is not depreciated. Depression: Part of the business cycle, a period of low economic activity characterized by high unemployment, low levels of investment, falling prices (including rents), reduced purchasing power, decreasing use of resources, and currency deflation. Development: A component of the real estate cycle. A period when occupancy is high, rents are rising, and absorption levels are high, usually coincident with increasing prosperity and leading to new construction to meet demand for housing and commercial space that exceeds the available supply. Also used in referring to developed real estate, as a large-scale or multi-building residential or commercial project that may be built in phases. Direct write-off: Method of dealing with delinquent accounts wherein tenants are evicted when their debt becomes uncollectable.

Balloon loan

Action occurring during the final stages of a loan wherein the last payment of a loan is larger than the previous monthly payments in order to fully repay the outstanding principal balance.

Accelerate

Action taken by a lender during foreclosure wherein immediate payment of the entire loan balance is required, which includes the entire amount due (delinquent mortgage payments, outstanding interest and principle, taxes, penalty fees, collection fees).

Before-tax cash flow (BTCF)

Amount of money remaining after operating expenses (including real estate taxes and debt service) have been bumped out before income taxes are considered.

Agency account

An account in which the real estate manager acts for the owner but without acquiring title to assets. The agent (real estate manager) acts for a principal (owner) and agrees to carry out certain duties with respect to the principal's (owner's) property. Serves a similar purpose as a trust account.

Broker

An agent with a real estate license who acts as a representative for an owner or tenant, within specific limits of authority. Also, an agent who buys, sells, or leases for a principal on a commission basis without having title to the property.

Annuity

An amount to be paid yearly or at other regular intervals, often on a guaranteed dollar basis. An insurance contract that provides a lump sum payout or makes a periodic payment for a specified period or for the life of the insured, beginning at a predetermined date. Money is paid into the fund in a lump sum or in the form of premiums until maturity. Payouts include a portion of the capital (premiums) plus accrued interest. The policy is designed to liquidate funds rather than accumulate them.

As-is analysis

An analysis of the impact of continuing to operate the property under the same or similar circumstances.

Capital budget

An estimate of costs of major improvements or replacements; generally a long-range plan for improvements to a property. Also used in referring to a long-range financial plan for acquiring and financing capital assets.

Appreciation

An increase in exchangeable value, as of money, goods, or property. Compare depreciation.

Controllable expenses

An operating expense for which management has defined responsibility and over which it has control (e.g., advertising, energy consumption, maintenance and repairs, and purchase of supplies).

Appraisal

An opinion or estimate of the value of a property. An estimate of value that is (usually) prepared by a certified or accredited appraiser. Four methods of appraisal are common—the cost approach, based on the estimated value of the land plus the estimated cost of replacing the improvements on it less depreciation; the market approach (also called sales approach), based on a comparison to similar properties in the market that have been sold recently; the income capitalization approach, based on the net operating income of the property; and the discounted cash flow method, which discounts all future fiscal benefits of an investment property over a predetermined holding period. All four are used to estimate value if sufficient information is gathered in each approach to do so.

Discount rate

Any rate used to translate a future dollar amount into an equivalent present value. Also, the interest rate the Federal Reserve Bank charges commercial banks.

Discounting

Calculating how much a future sum of money would be worth at present.

Economic vacancy

Commonly used in rental housing to mean all vacant units that are not producing income. In addition to physical vacancies, this includes units that are not available for lease (e.g., apartments used as models or offices, staff apartments, cannibalized units) as well as leased units that are not yet occupied and occupied units that are not producing rent (i.e., delinquencies); usually expressed as a percentage of the total number of units. (In other words, the number of unoccupied units may not always be an accurate reflection of the impact of vacancies.) A similar determination may be made for commercial properties based on unoccupied square footage. In economic terms, the rent dollars lost from such vacancies, expressed as a percentage of the gross potential income of the property.

Conformity

Concept that maintains that maximum value will be derived by a product that adheres to the demands of the widest part of the market.

Expense stops

Costs paid by the owner of an office or retail property to cover operating expenses of the building.

Fixed cost

Costs that do not change as occupancy rates change and are generally stable during a budget period. Fixed costs also include insurance costs and real estate taxes.

Appraised value

Estimate of market value of a property as of the date of an appraiser's appraisal report. Sometimes referred to as final value estimate.

CAM budget

Estimates the funds that will be needed for the coming year's operating expenses for areas not owned by any one tenant in an office or retail building.

Discounted cash flow (DCF)

Financial analysis using the time value of money to determine how much an investment held for several years into the future would be worth in present dollars.

Fee management firm

Firms that charge a fee to manage their properties.

Cash flow analysis worksheet

Forms used to organize financial analyses. These worksheets can be titled in many different ways, such as annual operating data and multi-year operating data.

Curb appeal

General cleanliness, neatness, and attractiveness of a building as exemplified by the appearance of the exterior and grounds and the general level of housekeeping. The aesthetic image and appearance projected by a property; the first impression it creates.

Amortization

Gradual reduction of a debt by periodic payments that include interest and a portion of the principal over the term of the loan.Amortization schedule/table: A table which separates a loan into its components of principal and interest across the life of the loan.

Economic obsolescence

Impairment of desirability or useful life of property, or its loss in use and value, arising from economic forces outside of the building or property, such as changes in optimum land use, legislative enactments that restrict or impair property rights, and changes in market conditions (e.g., supply-demand relationships).

Expense-stop method

In an office lease, a clause obligating the property owner to pay operating costs up to a certain amount per square foot per year; tenants pay their pro rata share of any costs in excess of that amount. When used in a retail lease, a clause obligating the tenants to pay a pro rata share of operating expenses up to a certain amount per year (expense cap); the owner pays any costs in excess of that amount.

Compounding

In banking, calculation and payment of interest on the principal and on any previous interest.

Closing

In salesmanship, persuading the customer to buy the product after the product has been explained and demonstrated; the last step in the sales process. The signing of a lease after negotiations have concluded. Used in apartment leasing to refer to the point at which the leasing agent's efforts have resulted in a prospective resident agreeing to sign a lease. More commonly in real estate, closing refers to the final transaction session at which the mortgage is secured (unless the sale is all cash), possession (title) of the real estate is transferred, and the money (consideration) changes hands.

Financial Accounting Standards Board

Independent agency responsible for setting Generally Accepted Accounting Principles (GAAP).

Equity investment

Investment in the form of a down payment made by a property owner when purchasing a new property.

Equity ownership

Legal right of possession. The owner or owners of a rental (apartment, office, retail, or industrial) building who contract for professional property management and/or employ a leasing agent(s).

Bundle of rights

Limited rights included with a property to surface area of the property above and below the property itself. These rights are limited by public and private restrictions based on local law.

Cash-on-cash rate of return

Measures an investor's rate of return on the capital invested, compares the equity invested with the before-tax cash flow for one year. The formula is: BTCF ÷ Initial Equity = Cash-on-Cash Rate of Return.

Base-year method

Method of calculating pass through expenses that requires tenants to pay a particular percentage of operating costs above those incurred in the base year.

Allowance for doubtful accounts

Method used for budget forecasting based on the assumption that there is no way to know which tenant account may become delinquent.

Account receivable

Monies due from others for services rendered or goods ordered and delivered.

Account payable

Monies due to others for services rendered or goods ordered and received.

Cash flow budget

Monthly or other projection of the cash position of a business (or investment property) accounting for all sources of income and all expected expenditures, including debt service and monies contributed to capital reserves as well as ordinary operating expenses, but excluding income taxes.

Best practices

Norms for operation used by the most ethical and honest companies established by industry practitioners, professional associations, and amongst firms.

Fiduciary

One charged with a relationship of trust and confidence, as between a principal and agent, trustee and beneficiary, or attorney and client, when one party is legally empowered to act on behalf of another.

Disbursement account

One of two types of accounts frequently kept for each client in a property. A disbursement account is often used to pay expenses relevant to the client and/or property.

Asset manager

One who is charged with supervising an owner's real estate assets at the investment level. In addition to real estate management responsibilities that include maximizing net operating income and property value, an asset manager may recommend or be responsible for or participate in property acquisition, development, and divestiture. An asset manager may have only superficial involvement with day-to-day operations at the site (e.g., supervision of personnel, property maintenance, tenant relations).

Appraiser

One who performs a formal, detailed estimate of a property's value. An individual who is qualified to estimate the value of real property.

Forbearance

Property workout in the form of a temporary period during which the lender of a defaulted loan withholds legal action so as to allow the property owner time to make the loan current.

Cash flow statements

Reports of the actual inflow and outflow of cash and its related sources and uses in a given accounting period.

Collection loss

Revenue loss consisting of bad debts, rents that may not be collected, and concessions.

Concessions

Revenue loss used to attract tenants (e.g., reductions to rent).

Capital expenditure(s)

Spending on capital assets, such as major improvements, large equipment, additions to buildings, buildings themselves, and land.

Effective interest rate

The actual rate of interest paid on a loan, which may include adjustments.

Cash flow

The amount of spendable income from a real estate investment. The amount of cash available after all payments have been made for operating expenses, debt service (mortgage principal and interest), and capital reserve funds; also called pre-tax cash flow to indicate that income taxes have not been deducted.

Due diligence

The duty of a seller to ensure that the offering statement does not misstate or omit pertinent information. The appropriate or sufficient level of care and attention that should be given during the examination or evaluation of a property, either as preparation for financing or refinancing or in an effort to identify environmental problems that must be addressed.

Effective Age

The estimated age of a structure based on its utility, observed deterioration, and obsolescence.

Accrual-basis accounting

The method of accounting that involves entering amounts of income when they are earned and amounts of expense when they are incurred, even though the cash may not be received or paid; also called accrual accounting. All certified audits must use accrual accounting. Compare cash-basis accounting.

Cash-basis accounting

The method of accounting that recognizes income and expenses when money is actually received or paid; also called cash accounting. Compare accrual-basis accounting.

After-tax cash flow (ATCF)

The money remaining for an investor after income taxes have been deducted; a real estate owner's net profit.

Fee simple ownership

The most complete type of private ownership of real estate which gives the titleholder the right to possess, control, use, and dispose of the property without time limitation, including the unlimited right to divide the property among one's heirs. Sometimes called fee simple absolute.

Abstract

The most important terms and financial clauses of a lease condensed into a form that is more easily accessible and understandable.

Fair market value

The price paid, or one that might be anticipated as necessarily payable, by a willing and informed buyer to a willing and informed seller (neither of whom is under any compulsion to act), if the object sold has been reasonably exposed to the market. In real estate, the price at which a property is sold to a willing buyer by a willing seller.

Annual interest rate (I/YR)

The rate of return, or the discount rate, on an investment. For a loan, it is the interest rate charged.

Contract rent

The rent stipulated in an existing lease, which may differ from the economic or market rent. In government-assisted housing, the total rent HUD (or the contract administrator) authorizes an owner to collect from all sources for a unit occupied by a family receiving assistance.

Eminent domain

The right of a government or municipal quasi-public body to acquire private property for public use through a court action called condemnation in which the court determines that the use is a public use and determines the price or compensation to be paid to the owner. (The owner of the property must be fairly compensated, usually based on an appraisal of the fair market value.)

Commercial mortgage-backed security (CMBS)

The secondary market for commercial mortgages, in which commercial mortgages are bundled and securitized.

Effective gross income (EGI)

The total amount of income actually collected during a reporting period; the gross receipts of a property. Gross potential rental income, less vacancy, and collection losses plus miscellaneous or unscheduled income.

Capitalization

The treatment of future income as part of a firm's capital. In appraisal, the process employed in estimating the market value of real property by applying a proper investment rate of return to the annual net operating income expected to be produced by the property, the formula being: Income (I) divided by Rate (R) equals Value (V), or I ÷ R = V—the IRV formula.

Book value

The value of an item, such as real property, as stated in books of account and differentiated from its market value. Calculated as the cost of a property, plus capital additions, less accrued depreciation (cost recovery) that has been charged off for income tax purposes and partial sales. Compare market value. Also, the value of capital stock (as of a corporation) based on the excess of assets over liabilities.

Equity

The value of real property in excess of debt. The interest or value that an owner has in real estate over and above the mortgage and other financial liens against it; outright ownership. In accounting, the excess of a firm's assets over its liabilities.

Accrue

To accumulate growth or value to an asset over a period of time.

Commingling

To mix or combine; a prohibited practice in real estate wherein the money of more than one person or entity is combined into a common fund.

Annual debt service (ADS)

Total payments, of both principal and interest, per year to one or more lenders.

Common area maintenance (CAM)

Upkeep of areas not owned by any one tenant in an office or retail building. Comparable sales approach: (See market data approach.)

Debt financing

Use of borrowed funds to invest in real estate.