RE
Income Tax Shield
A reduction in tax liability resulting from the ability to deduct interest payments from taxable income.
Going Dark
Occurs when an anchor tenant, who pays little rent, decides to close their store despite have a long-term outstanding lease term. This tenant may then choose to conduct its operations at a nearby competing property. Such an event can dramatically-reduce a property's consumer traffic, damage the performance of inline stores, and, consequently, prove detrimental to the asset's revenue streams. Property owner can mitigate this risk by establishing lease terms that impose financial penalties on the anchor or tenant or completely prohibit the practice while there is a specified amount of time remaining on the lease.
Discounted Cash Flow (DFC) Analysis
Potential investment value is estimated by finding the present value of future cash flows at a certain discount rate.
After-Tax Cash flow =
Pre-Tax Levered Cash Flow - Income Tax Liability
Income Tax Liability
What property owner will owe in income tax.
Calculating Value of Other Assets
"Other Assets" may include - Development Project Underway - Land Held for Future Development or Sale -Other Investments in Unconsolidated Subsidiary (Year X) The value of Other Assets is the sum of these Other Assets
Credit Loss =
(Expected Credit Loss % of Expected Gross Income) * Expected Gross Income
*IMPORTANT FORMULA* Long-Term Cash Flow Growth =
(Expected Real Cash Flow Growth) + (Economy wide Inflation)
*IMPORTANT FORMULA* Acquisition Cap Rate =
(Property NOI) / (Property Value Including Land)
Three Components of Rent
1) Base Rent 2) Base Rent Escalations 3) Percentage Rent
Advantages of Pre-Sale (2)
1) Can prove the market demand of the product 2) Buyer deposits can be used to help fund the remaining development of the project (reduces the developer's equity requirements)
Non-Audited Free Cash Flows Metrics (2)
1) Funds from Operations (FFO) 2) Adjusted Funds from Operations (AFFO)
Cons of Pre-Lease
1) Inability to take advantage of increased market rental rates 2) In weak markets: - offer discounted rents -offer leasing concessions -may have to offer preferred space 3) Increased risk of a future tenant going bankrupt before lease term ends 4) May create a false sense of security
*IMPORTANT FORMULA* What are the Three Main Financial Statements?
1) Income Statement Revenues - Cost of Good Sold - Expenses = Net Income 2) Balance Sheet Assets = Liabilities + Stockholders' Equity 3) Statement of Cash Flows Beginning Cash + CF from Operations + CF from Investment + CF from Financing = Ending Cash
Types of Property Development Costs (3)
1) Land acquisition costs 2) Hard Costs 3) Soft Costs
Advantages of Pre-Lease (2)
1) Less Uncertainty related to future cash flows 2) Less tenant credit risk
Common Opportunities
1) Operating Expense Manipulation 2) Terminal Value 3) Rental Growth
Two Business Phases of Development
1) Phase 1: The Negative Cash Flow Business 2) Phase 2: The Positive Cash Flows Business
Effects on Debt on Cash Return
1) Positive Leverage 2) Negative Leverage
Disadvantages of Pre-Sale (2)
1) Units are typically sold at a discount ("leaving some money on the table" 2) Lenders may not release any funding til a threshold percentage of the project is pre-sold at prices no less than agreed up release prices (Revenue risk mitigation is lender-enforced)
1031 Identification Process
1. A QI sets up an agreement so that an escrow or closing agent transfers the property to a buyer and that the sales proceeds go directly to the QI. 2. The exchanger (original property owner) is required to acquire a new property within a limited number of days. a.) New property cannot be owned by a subsidiary or employee of the exchanger. b.) Property cannot be owned by other "disqualified persons" under IRS Codes. 3. Once identified, the new property must be designated as a "replacement" by the exchanger. 4. The exchanger must send the designation to the person from whom the exchanger will acquire the new property.
Two Most Common Reasons for Refinancing
1. A property has risen substantially in value, allowing the debtor to notably increase the amount of debt on the property. 2. Mortgage interest rates have fallen substantially relative to what the borrower is paying on their existing mortgage.
2016 Ownership Shares of U.S. Commercial Mortgage Assets
1. Banks (60%) 2. Insurance Companies (14%) 3. ABS Issues and Finance Firms (14%) 4. Mortgage REITs (7%) 5. Other (5%) 6. Pension and Retirement Funds (1%)
Two Inextricable Links Between States of the Economy
1. Capital Markets 2. The Boom and Bust of Property Prices
Seniority of Consideration in Debt Repayment for Ch. 11 Firm
1. Creditors who have provided fresh capital to a firm in Chapter 11 2. Senior Creditors 3. Junior Creditors 4. Equity Holders
Three types of REITS
1. Equity REITs: Most common REIT format. Own and operate income producing real estate and are typically managed by low-leverage investors. Revenue is derived primarily from rental revenue streams. 2. Mortgage REITs: Lend money directly to real estate owners or extend credit indirectly through the acquisition of loans or mortgage-backed securities. Revenue is derived primarily from the interest on mortgages they own. 3. Hybrid REITs: Possess element of both equity and mortgage REITs.
Valuation Methods of a Property Subject to a Ground Lease (4)
1. Ground Lease Payment DCF 2. Ground Lease Payment Capitalization 3. Building Net Operating Income DCF 4. Building Net Operating Income Capitalization
3 types of Fund Expense
1. Investment Banks (IBs): Have access to high net worth individuals, deal flow, and capital markets expertise. Favored for their established networks and competitive advantage in raising money. Are experts in corporate finance and have the expertise to add value to deals by creatively financing and selling complex deals. 2. Investment Houses: Increasingly prevalent within Real Estate Private Equity over the past 20 years. Their funds are typically stand-alone vehicles which are part of a larger family of funds, including corporate LBO funds, venture capital funds, hedge funds, and distressed debt funds. This umbrella investment strategy allows them to raise money for all of their funds under one brand and from the same investment base. Rely heavily on their credibility, reputation, and track record. 3. Dedicated Real Estate Players: Historically, these funds are headed by professionals with long careers in real estate and who have mastered the art of raising money. Tend to be relatively focused, with their competitive advantage being the identification of opportunistic investments and property-level expertise.
Composition of a Property's Discount Rate
1. Long-term risk-free rate (approximated by the yield of 10-Year Treasury Bonds) 2. Expected economy-wide inflation 3. Risk premium associated with unexpected outcomes in the property's NOI 4. Risk premium associated with the property's illiquidity relative to a 10-Year Treasury Bond
Two Common Promote Structures
1. Most often, "the money" and the sponsor split the profits, including those of the preferred return. 80% goes to "the money" and 20% goes to the sponsor, as long as "the money" receives all of their invested capital back and the preferred return. If the fund fails to exceed the Pref, no sponsor promote is earned, and profit distributions are paid 100% to "the money," pari passu. 2. Less often, there is an alternative waterfall structure with the payout of 80% to "the money" and 20% to the sponsor just on the residual split. Difference is irrelevant if the Pref is not met, but provide the sponsor with a notably disproportionate return if the fund is successful.
Equity Key Performance Indicators (KPIs)
1. Net Cash Flow (Net Profit) 2. Internal Rate of Return (average compounded annual return) 3. Net Present Value (value created in discounted dollars) 4. Multiple on Equity
Types of Loan Covenants (2)
1. Positive Covenants: "Things you must do" 2. Negative Covenants: "Things you cannot do"
Two Main Reasons for a 1031 Exchange
1. Sell a stabilized property, while purchasing a property where there is an opportunity to add value. 2. Sell a property and purchase a stabilized building that offers a better refinancing opportunity and a reduced management burden.
Two Main Outsourced Loan Management Specialists
1. Servicer: Is responsible for assuring that the borrowers are in compliance with their loan documents and taking the appropriate actions if the borrower is in default. Also ensures that the investors and IRS receive all pertinent information in a timely manner. 2. Special Servicer: Takes control of the administration of any non-performing loans. Receives a small fee for being prepared to take over any non-performing loans as well as an incentive-related fee for dealing with any defaults that arise.
Most Common Problems with Premature Refinancing
1. Time, costs, and energy involved 2. More stringent lease terms 3. Prepayment Penalties
Primary Sources of Due Diligence Analytics
1. Title, Survey, Environmental, and Legal 2. Revenue 3. Operating Expenses 4. Capital Expenditures 5. Loan Documents 6. Neighborhood and Market
Four Reasons to Use Debt in a Transaction
1. You simply do not have enough money to buy an asset. 2. Even if you have enough money to buy an asset, you want to diversify your investments. 3. You desire the tax shield that comes with interest payments. 4. You seek to enhance the return on your equity.
*IMPORTANT FORMULA* Net Profit from CMBS Packaging =
= (CMBS Pool Sale Proceeds) - (CMBS Packaging/Issuance Costs) - (Individual Loans Originated)
*IMPORTANT FORMULA* Anticipated Total Annual Return =
= (Expected Annual Cash-on-Cash Yield) + (Expected Annualized Capital Appreciation)
*IMPORTANT FORMULA* Origination Profit =
= (Loans Originated) * Fee Rate
*IMPORTANT FORMULA* Discount Rate =
= (Long-term Risk Free Rate) + (Economy-Wide Inflation) + (Asset Operating Risk) + (Asset's illiquidity versus the Risk Fee Rate)
*IMPORTANT FORMULA* Total Purchaser Cash Flow =
= (Pool Purchase Price) + (Interest Payment Stream) + (Return of Principal)
*IMPORTANT FORMULA* Value of REIT after IPO =
= (Pre-IPO Value) - (IPO Fees)
After-Tax Cash Flow to Equity =
= (Pre-tax cash flow yields) - (Tax Liability)
*IMPORTANT FORMULA* Building NOI =
= (Property NOI) - (Ground Lease Payment)
*IMPORTANT FORMULA* Building Value =
= (Property Value) - (Land Value)
*IMPORTANT FORMULA* Equity Return from Capital Appreciation =
= (Residual Equity Value/Original Equity Investment) - 1
*IMPORTANT FORMULA* Cap Rate =
= (Risk Free Rate) + (Asset's Operating Risk) + (Asset's Illiquidity versus Risk-Free Rate) + (Expected Real Cash Flow Growth Rate)
*IMPORTANT FORMULA* Value of Property Portfolio =
= (Stabilized NOI in Year X) * (Property Ownership Cap Rate%)
*IMPORTANT FORMULA* Gross Income =
= (Total Rental Income) + (Expense Reimbursements for CAM Billings) + (Expense Reimbursements for Property Tax Billings) + Ancillary Income
*IMPORTANT FORMULA* Floor Area Ratio (FAR) =
= (Total Usable Building Floor Area) / (Total Site Land Area)
*IMPORTANT FORMULA* Gross Value of Assets =
= (Value of Property Portfolio) + (Value of Other Income) + (Value of Other Assets)
*IMPORTANT FORMULA* Loans Originated =
= (initial issuanceamount) * CMBS Pools per Year
*IMPORTANT FORMULA* Gross Revenue =
= Base Rental Revenues + Expense Reimbursement Revenue
*IMPORTANT FORMULA* Equity Value =
= Capped Stabilized NOI - Debt in Year X or = (PV of Cashflows at Y%) - Average Debt Outstanding (Year X)
*IMPORTANT FORMULA* Interest Payment =
= Debt * Interest Rate
*IMPORTANT FORMULA* NOI =
= EGI - Total Expenses
*IMPORTANT FORMULA* 1031 Exchange: Equity for New Projects =
= Equity Freed - Equity in Asset - Fees on Purchase
*IMPORTANT FORMULA* 1031 Exchange: Net Equity =
= Equity in Asset + Equity for New Projects
*IMPORTANT FORMULA* Market Premium =
= Expected Market Rate of Return - Risk Free Rate
*IMPORTANT FORMULA* Expected Yield on Cost =
= Expected Stabilized NOI / Expected Total Costs
*IMPORTANT FORMULA* Net Book Gain-on Sale =
= Gain on Sale - Application of Unutilized Suspended Losses
*IMPORTANT FORMULA* Net Sales Price =
= Gross Sales Price - Selling Costs
*IMPORTANT FORMULA* Pool Sale Proceeds =
= Initial Proceeds Amount * CMBS Pools per Year
*IMPORTANT FORMULA* Total Development Cost =
= Land Costs + Hard Costs + Soft Costs
*IMPORTANT FORMULA* Loan-to-Value (LTV) Ratio =
= Loan Amount / Value of Asset* *Higher LTVs are risker, resulting in higher cost loans.
*IMPORTANT FORMULA* Interest Payment Stream =
= Loan Principal Amount * (Interest Rate) or = (Loans Originated) * Interest Rate
*IMPORTANT FORMULA* Rent per Leased SF =
= Market Rent Per LSF * (1 - Stabilized Vacancy %)
*IMPORTANT FORMULA* Maximum Land Cost =
= Max Land Cost * GSF
*IMPORTANT FORMULA* Value =
= Multiple * Stabilized NOI = Stabilized NOI / Cap Rate
*IMPORTANT FORMULA* Net Cash Flow from Operations =
= NOI - CAPX - Interest + Tax Shelter Sales
*IMPORTANT FORMULA* Property Cash Flow Yield % =
= NOI after Normal Reserves/Purchase Price Cash Flow to Equity = NOI - Interest
*IMPORTANT FORMULA* Effective Gross Income (EGI) =
= Net Base Rental Revenue + Ancillary Income
*IMPORTANT FORMULA* Base Rental Revenue Growth =
= Prior Period Base Rental Revenue * Growth Rate %
*IMPORTANT FORMULA* Residual Equity Value =
= Property Sale Value - Debt Repayment
*IMPORTANT FORMULA* 1031 Exchange: Equity in Asset =
= Purchase price - Debt (X%LTV)
*IMPORTANT FORMULA* CAPM =
= Risk Free Rate + Market Beta * (Market Premium)
*IMPORTANT FORMULA* 1031 Exchange: Equity Freed =
= Sales Price - Debt (X%LTV) - Fees
*IMPORTANT FORMULA* Total Income Tax Liability =
= Tax on Accumulated Depreciation + Capital Gains Tax Liability
*IMPORTANT FORMULA* Net Cash Flow to Purchaser =
= The Sum of All Total Purchase Cash Flow Amounts
*IMPORTANT FORMULA* Multiple =
= Value/Stabilized NOI = 1/Cap Rate
*IMPORTANT FORMULA* Ground lease DCF =
= Year X Terminal Value = (Year X Ground Lease Payment)/(Terminal Cap Rate)
*IMPORTANT FORMULA* Net Pre-IPO Equity =
= [Property Value (+/- X%)] + [Management Fee Stream Value] - [Debt]
Tranching
A CMBS industry norm that involves the creation of 8-15 separate ownership claims of differing priority on the commingled stream of cash flows from the underlying pool of mortgages.
Draw Request
A borrower's request that a lender advance funds under a construction or other future-advances loan. To be considered or approved, must have a legitimate and fully documented purpose.
Lien
A change
Mezzanine ("Mezz") Finance
A highly customized area of financing. Is a hybrid of debt and equity financing that provides the lender the right to convert to an equity interest in the borrowing firm in the event of a default, generally after senior lenders have been paid. Usually involves little to no collateral and is counted as equity on the balance sheet. Involves every type of financing that is not secured by real estate.
Non-Recourse Loan
A loan secured solely by the asset's associated with the property.
Secured Loan
A loan which is secured by the assets of the property. If the debtor defaults, the creditor is entitled to foreclose on the secured assets to satisfy their claim.
Investment Commitment
A minimum amount of capital an investor must offer in order to participate in a private equity fund. Promised commitment is drawn down on an "as needed" basis through capital calls. Usually, the minimum commitment is $1 million, limiting individual investment to high net worth individuals.
Release Prices
A minimum price set by a construction lender for what a developer can pre-sell a unit for.
Fixed Rate
A nominal rate locked-in for the duration of the loan period.
Capital Gains Tax
A tax levied on the sale of a real estate asset or similar investment. Calculated on the profits or positive difference between the asset's sale price and its original purchase price. Is only triggered when the sale of the asset is realize, not when it is held by the new owner.
Subprime Mortgages
A type of mortgage that is normally issued by a lending institution to borrowers with low credit ratings and greater associated risks of default. Interest rates on subprime mortgages are usually higher than those on conventional mortgages in order to compensate for risk.
Qualified REIT Subsidiary (QRS)
A wholly-owned subsidiary of a REIT which meets regulatory requirements and satisfies REIT tax codes.
Loan Points
A.k.a origination costs. Fee paid to the lender to compensate for the lender's underwriting costs, Are approximately 50 bps of the loan and must be amortized over the term of the loan for tax purposes.
Capital Structures
A.k.a. Capital Stacks. Illustrates a project's composition of debt and equity financing and proportions.
Promote
A.k.a. Carried Interest. Is the mechanism which provides the fund sponsor with a financial incentive to maximize the fund's returns, as it is a share of the profits awarded for their "sweat." If a fund is very successful, the sponsor may receive a beneficially disproportionate share of fund profits relative to their cash investment.
Multiple Equity
A.k.a. Equity Multiple or Multiple on Invested Capital. How many times you get your investment back.
Debt Service Expense
After calculating EBITDA, you must deduct cash flows relating to financing. Total debts payments are the sum of interest and principal payments made for each existing property mortgages as well as any unsecured corporate debt and lines of credit, debt service payments associated with additional debt that the firm plans to undertake for new developments, and debt for net acquisitions and dispositions.
Synthetic Lease
Allows a company with an economic and tax ownership position to hide ownership (and associate debt) from shareholders. Is a type of contract that attempts to convince the IRS that you own the real estate, while also satisfying the SEC that your rent the property. If executed successfully, it provides a tax shield while also creating the opportunity for favorable balance sheet manipulation.
Sweep Provision
Allows the lender to take all of a property's cash inflows until the borrower's loan obligations are satisfied.
Development Feasibility Analysis
Also known as "back of the envelope" analysis. Is a pro forma analysis of a proposed development to determine whether or not the expected opportunities and revenue streams for a new project can offset its associated costs and risks.
*IMPORTANT FORMULA* Adjusted Funds From Operations (AFFO) =
Also known as Funds Available for Distribution (FAD) and Cash Available for Distribution (CAD). One of the two non-audited free cash flow metrics. Is used to measure a real estate firm's cash available for distribution to shareholders without deterioration of its asset base. Is regarded as a closer metric than FFO. AFFO = FFO - Expected Recurring CAPX - Tis -LCs - Adjustments* *Adjusted for "Straight-line Rent" and Financial Accounting Standards 141/142/143
Floating Rate
Also known as a variable rate. Rates adjust with the debt markets and the rate that the borrower pays are reset at a negotiated time interval.
Wealth Position =
Also known as net equity. Is the post-sale cash amount after deducting the repayment of a loan, payment of sales fees, and tax payments to the IRS. Net Equity = Sales Revenue - Debt - Sales Fees - Capital Gains Tax - Depreciation Tax
Real Estate Private Equity Funds
Also known as opportunity funds, these investment vehicles are among the largest owners of real estate in the U.S. Raise large pools of equity prior to investing to ensure that equity is readily deployable. Have limited lifespans, typically ranging from 7 to 10 years.
Net Leasable Square Footage (LSF)
Also known as rentable square footage. Refers to the amount of floor area that can be leased
Going-in Cap Rate
Also known as the return on cost or yield on cost. Determines the cap of a property based on is first year's projected stabilized NOI relative to the total cost of a property's construction. "To build to X."
Mileage Rate
Amount per $1,000 of property value that is used to calculate local property taxes. Assigned millage rates are multiplied by the total taxable value of the property in order to arrive at the property taxes.
White Elephant
An investment that is expensive, unprofitable, and difficult to sell. They are among the least desirable investments in a market.
Debt Service Coverage Ratio (DSCR) =
Annual NOI divided by total annual debt service expense. If debt covenants for a loan require a minimum DSCR, there can be violations in years when NOI is weak. This means that most operators will avoid flirting with breaking loan covenants by always seeking ways to squeeze every dime out of operating costs. = Annual NOI/Total Annual Debt Service Expense The annual NOI of the property divided by the annual debt service payment inclusive of both principal and interest. Generally, DSCR for secured first mortgages must exceed 1.2x. DSCR = Expected Annual NOI/Total Annual Debt Service Payment* *Interest and Principal
Interest Calculation Bases: Actual /360 (aka 365/360)
Annual rate is divided by 360 (not 365) days and then multiplied by 365 (366 during leap years). Is the most expensive to the borrower.
Debt Yield =
Another metric used by lenders when determining the appropriate size of a loan and is expressed as a percentage. Can be considered the "lender's cap rate" with a target rate of 8%-13%. Is the first year's NOI divided by the loan amount. Debt Yield = First Year's NOI/Principal Amount on the Loan
Signage
Applies mainly to retail properties. Lease terms can place restriction on the size, location, and content of signs placed by retail tenants.
"Good news Money"
Applies to acquisition loans that allow for delayed draws for capital costs relating to the occupancy of new tenants.
Agglomeration Economies:
Areas filled with firms in the same or a similar business. Close proximity allows them to become more productive by sharing information, infrastructures, and a pool of relevant workers. They can also reduce transportation costs of their common inputs and outputs.
2030 Absolute Growth Forecast Leaders (8):
Atlanta Washington, D.C. New York City Houston Chicago Dallas Richmond Minneapolis Top 10 Absolute Growth MSAs are forecasted to increase in population by 12.1 million by 2030
A Common Mistake in Development Feasibility Analysis
Avoid Trending recent rental data points when conducting feasibility analysis - Extrapolating points at the same slope - Rent is driven by supply and demand, not trend lines
Cram Down Rule
Bankruptcy code that allows a bankruptcy court to force a dissenting party, often an unhappy lender, to accept a reorganization plan.
Section 11.11B
Bankruptcy code that allows for the lender to waive its deficiency claim. Useful if the lender expects the borrower to default, relabeling an unsecured deficiency claim as a secured claim. If the borrower defaults, this protects the claim being completely lost.
Easement "In Gross"
Benefits a person or company, rather than another parcel of land. A common example of this is public utilities (i.e. power lines).
Soft Costs
Broadly defined as indirect costs. Largest soft costs are from architects, engineers, and construction loan interest costs. Also covers development overhead.
Compounded Equity Growth Rate
Calculates the annual equity capital appreciation which is then used to determine anticipated returns. The greater the proportion of debt financing in a capital structure, the higher the expected equity appreciation return. This illustrates the equity magnifier resulting from debt financing. CAGR = (1+Total Return) ^ ((1/# of Years) - 1)
Residual Value
Calculation of a property's value upon sale and is a dominant part of cash flows via disposition.
Outstanding Loan Put Option
Can be exercised by the debtor if there is no additional collateral. If the property's value falls below the loan balance, the debtor can, de facto, sell the property to the creditor. As a result, a creditor should consider their loan balance to effectively be a standing offer to purchase the asset at the loan balance.
Cap Rate Valuation
Can only be used when the property's NOI has been stabilized. If a property's NOI is unstable, DCF analysis should be used instead to create a meaningful valuation estimate.
Going-Out Cap Rate =
Cap rate used to determine what a developer can sell a finished property for using value created. Used projected NOI relative to a projected sales price. " To sell to X." Going-Out Cap Rate = Projected Stabilized NOI/Projected Sales Price
Expense Stops
Caps specified in a lease that limit the extent to which certain cost items can rise over the course of a year or the term of the lease. Often applied to pro rata insurance and tax expenses incurred by a tenant on a square foot basis.
Capital Expenditures (CAPX)
Cash spent by landlord for repair and replacement of major property elements not located in the tenant premises (i.e. HVAC systems, boiler, elevators, etc.).
Clear Height
Ceiling height that provides ease of entry and exit into a property. Specifications vary by the use of the property.
Property Taxes
Collected by the local government and must be paid regardless if the property generates revenue. Calculated based on a millage rate applied to an assessed tax value. A pro rata vacancy adjustment is made for vacancy non-recovery. Landlords may appeal tax assessment if they feel it does not accurately reflect the level of property vacancy.
Light Assembly Space
Combines warehouse, product assembly, and office space and may be multi-tenanted. Typically, designed by warehouse principles with simple structure allowing for easy reconfiguration.
Pre-Sale
Common with residential properties such as condos. Developers can pre-sell a minority portion of unit inventory based off the strength of their marketing program. Units are usually sold at a discount to the pro forma pricing for completed units.
*IMPORTANT FORMULA* Net Asset Value (NAV) =
Commonly used RE firm valuation method which assumes that management neither adds nor subtracts value. NAV = Gross Value of Assets - Total Liabilities - Preferred Stock
Trade Area Analysis
Conducted for contemplated retail developments to determine whether or not an area is over or under retailed.
*IMPORTANT FORMULA* Gordon Growth Model =
Converts perpetuity DCF for a cash stream growing at a constant rate into a simple cap rate approximation by dividing stabilized NOI by the difference between a property's discount rate and its NOI growth rate. Gordon Value = NOI/(Property Discount Rate - NOI Growth Rate) = NOI/Cap Rate Thus: Cap Rate = Property Discount Rate - NOI Growth Rate
Rezoning Costs
Costs associate with changing zoning ordinances or if any variances are sought for the use of the land.
Eligible Loan Costs
Costs for property elements that have collateral value to the lender and, thus, liquidation value in the event of foreclosure. Applies to both LTV and LTC. Origination fees paid to a third-party mezzanine lender or a deal sponsors acquisition fee do NOT apply.
Operating Expenses
Costs relating to the daily operation and maintenance of the property. Includes utilities, insurance, property taxes, etc.
Chapter 11 Bankruptcy
Created in 1978 and codified the view that a distressed firm's reorganization was preferable to liquidation. Provides the distress debtor with a 180-day exclusivity period, during which time only the debtor can submit a reorganization plan and secured creditors cannot immediately seize their collateral. Chapter 11 aims to conserve going- concern value, generally requiring a consensual reorganization plan.
Like-Kind Exchange (1031 Exchange)
Currently, can be found as a part of U.S. tax code, IRS Section 1031. Essentially allows the owner of a property to sell the asset free of state and federal income taxes if they purchase a "similar" property within a prescribed period of time, therefore forestalling capital gains taxes until the ownership chain is broken. Allows the owner to restart their depreciation schedule.
Assumable Debt
Debt that is assumed by a new owner as they take on a property and the previous owner's debt.
Unsecured Debt
Debt that is not backed by an underlying asset and often occurs when there is a deficiency claim.
Chapter 7 Bankruptcy
Debtor ceases all operations, goes completely out of business, and a trustee is appointed to sell the property and other assets to pay off obligations with the sales proceeds.
Selling Costs
Deducted from GSP to determine the net sales price. Primarily comprised of sales brokerage commission, but may also include jurisdictional property transfer taxes.
Underwater
Describes a loan where the property value has fallen below the outstanding loan amount.
Amortization Schedule
Details the repayment of borrowed principal and interest over a fixed term. Is usually on a monthly or quarterly basis.
Land Optioning
Developer options, rather than purchases, the land during the approval phase to reduce the risks and defer the large land closing payment. Provides the developer the exclusive right to acquire the land at a specified price and date and prevents the land owner from marketing the land during the option term. A non-refundable option amount of 3-10% of the total land price is paid upfront, with the remainder due at the developer S option at some future land closing date.
Development Going-In Cap Rate =
Development Going-In Cap Rate = Projected Stabilized NOI/Projected Total Costs
Tis and LCs
During periods where a property is experiencing high levels of vacancies, Tis and LCs can be employed to obtain and retain tenants Increase marketing efforts through LCs and advertising Tis and allowances will be needed to attract new tenants and re-lease vacant space
Development Overhead
Encompasses expenses such as project management salaries, back- office work, accounting services, and legal fees.
Possible Maximum Loss (PML) Test
Examines the structural integrity of a structure. The higher a building's score, the worse its structural integrity and greater the associated risks.
Loan Default
Failure to repay a loan in accordance with agreed upon terms of the promissory note. Is caused by extended delinquency and, in real estate, is often attributable to poor tenant quality and associated rental streams.
Leasing Comissions (LCs)
Fees that the landlord pays to a broker or leasing company that leases landlord's space. Generally, corresponds with the lease expiration schedule. Landlord usually pays both the landlord-side and the tenant-side broker commissions, which are typically structured as a percentage of the total gross rent over the term of the lease, Payment of LCs is usually half at lease signature and the balance at rent commencement.
Return of Capital
Focuses on when, and with what certainty, investors will receive their invested capital back. Is typically the primary concern of private equity funds.
Brokerage Commissions
For investment sales brokers, fee is negotiated and taken as a percentage of the GSP. Typically is less than 2%, but may be higher if the sale proves to be difficult.
TI Allowance
Funds set aside by the landlord meant to be used on executing Tis based on pre- negotiated lease terms.
Minority Interest
GAAP requires that firms with controlling shares in an operating partnership and its assets must report the associate assets on their balance sheet as if they had 100% ownership. Management then must make an adjustment to reflect the portion of operating partnership and asset income which they receive.
Investment Return Profiles: Value-Add Funds
General: • Take on greater upfront risks with the expectation of greater profits late in the investment Horizon -Generally negative returns in the early years of investment -Will under-perform relative to NACREIF and NAREIT during this time, even if they ultimately exceed their business plan. -Difficult to determine if weak performance is temporary or permanent • True risk of value-add investments is not poor market conditions, but the inability of their managers in adding value Qualitative Differences: • Illiquidity can be mitigate through re-financing, which is a much simpler and tax- advantaged transaction than an outright sale • Low-Transparency • Amount of capital put to work depends on the availability of desirable investments and the ability to win control of those investments • Reporting lacks a meaningful return benchmark • No investor operating control, high cash flow volatility, and are difficult to exit. • Aligned investor-manager interests due to de facto promote structures
Capitalization (Cap) Rate definition and Basic Cap Rate =
Generally quoted in real estate valuation analysis instead of income multiples. Expressed as a percentage and is the inverse of the income multiple. Lower caps indicate a relatively high price paid per dollar of property income. Basic cap rates employ the NOI for calculations. Basic Cap Rate = Stabilized NOI/Property Value = 1/Multiple
Vacancy Notes
Generally, moves inversely with the strength of the market. - Weaker the market, the greater the vacancy During downturns, low quality building experience the greatest growth in vacancy rates as tenants move to higher quality buildings with reduced rents
Going-In Cap Rate Example
Going-In Cap Rate Example A property has a projected stabilized NOI of $1,000,000 and a total construction cost of $10,000,000. Thus, you plan to "Build to 10." Going-In Cap = $1,000,000/$10,000,000 = 10% Going-Out Cap Rate Example -You have recently finished a development with a projected stabilized NOI of $1,000,000 and plan to sell the property for $12,500,000. Thus, you plan to "Sell to 8." Going-Out Cap = $1,000,000/$12,500,000 = 8%
Total Operating Income (TOI) =
Gross Income less expected credit loss. Gross Income - Credit Loss
Encumbered Real Estate
Has a lien or other financial liability attached to the property, resulting in future expected costs. Usually does not prevent the transfer of property ownership, but should be taken into consideration. Physical encumbrances, such as telephone poles on your property, may also exist. All known encumbrances will be listed on the site's legal property description.
Run Rate
How much is being spent on a daily, weekly, or monthly basis during the development stage. Usually low at the beginning, rises once construction gets into full swing, and stabilizes upon completion at your interest-carry cost.
Debt Repaid with IPO Proceeds =
IPO Equity Raised - IPO Fees
Volcker Rule
Important component of the Dodd-Frank Wall Street Reform. Restricted U.S. banks from making certain kinds of speculative investments that do not benefit their clients. Significantly decrease the presence of IBs as the dominating funds sponsors.
Non-Recourse Mortgages
In the event of default, creditors can only look to the property to recoup owed interest and principal. Cannot go after the debtor's personal assets to satisfy the claim and, thus, the creditor cannot file a deficiency claim for insufficient value from the property.
Claw-Back Provision
In the event that fund profits are over-allocated to the sponsor, this provision is triggered and returns the excess share of total profits to "the money" to comply with the percentage cap on distributions received by the sponsor.
Landlord Concessions
Incentives offered by the landlords to entice tenants to rent space at their property. Include free or lower rents, lower security deposits, additional services offered by the property's management, etc.
Land Acquisition Costs
Include the purchase price of the site and the associated transfer costs.
Lock-Out Clause
Included in a loan contract and completely prohibits early repayment on a loan for a specified period of time. Common in long-term loans.
Utilities
Includes water, electric, gas, and oil usage. Modern properties have separate utility meters for each tenant. Payment structure is determined by lease negotiations.
Double Taxation
Income generate from an income-producing asset, such as real estate, is taxed twice. Once to the firm or corporation holding the fund and once to the shareholders on the dividends which they receive. Applies to C-corporations.
Ancillary Income
Income generated from all other activities conducted at the property other than rent revenue.
Taxable Income
Income property owner receives from the property according to IRS rules. Adjustments to pre-tax cash flow are made to derive taxable income. This can be manipulated by real estate owners to mitigate tax liabilities.
Qualified intermediary (QI)
Independent specialist appointed to help sell a property in a 1031 exchange. Purpose is to set up an agreement, so that an escrow or closing agent transfers the property to a buyer and that the sales proceeds go directly to the QI. This is done to avoid capital gain taxes.
Reimbursable Expenses
Initially paid by the landlord, who is eventually compensated by tenants. Depending on negotiations, different expenses are reimbursable.
Due Diligence
Investigation made by an investor prior to making an investment and serves as the foundation for informed decision making. Involves verifying and analyzing the facts about a property and the surrounding market as well as questioning the robustness of current quantitative financial models (Challenge pro forma models). Considerations include legal liabilities, exit strategies, tenant qualities, existing lease terms, existing debt obligations, future CAPX, and many, many more.
Distressed Loan Investor
Investor whose business model is buying loans from banks at discounts to the unpaid principal balances. For the lender selling the debt, this removes some of the associated default costs and lets them write off the remaining loss on debt.
Defeasance
Involves a substitution of collateral (Treasury Bonds for Real Estate). Requires the borrower to use the proceeds from refinancing to purchase a portfolio of US Treasuries sufficient to make all the remaining loan payments, which are pledge to the original lender.
Yield Maintenance
Is a way to prepay a loan and make the creditor whole on the unpaid they would have received if the debtor had not prepaid. Debtor pays the lender the unpaid principal amount along with the present value of the scheduled amortizing debt service payment amounts over the remaining term versus a replacement interest rate. The discount rate used is typically the yield on a very short-term T-note.
Limited Partner (LP)
Is an individual or institutional investor in a private equity fund. If they fail to satisfy a call on their funding commitment, they forfeit many of their rights and economics.
Turner Building Cost Index (TBCI)
Is published by Turner Construction and tracks the overall cost of construction on a national basis. Accounts for material prices, labor rates, productivity, and competitive condition of the market place.
Cash-on-Cash Yield =
Is the cash yield determined by the cash flow to equity relative to the equity investment. Pre-tax cash flow to equity is found by deducting debt service payments from NOI. Cash-on-Cash Yield = Cash Flow to Equity/Equity Investment
General Partners (GP)
Is the fund sponsor who manages the limited partnership and is responsible for all of its operations.
Interest Coverage Ratio (ICR) =
Is the property NOI divided by the annual interest payment. Indicates how many times NOI can cover the interest obligation and gives the lender an idea of how much of an income cushion the borrower has in terms of their ability to pay the loan's interest. The higher the ratio, the greater the cushion and the safer the lender feels. ICR = Expected Property NOI/Annual Interest Payment
Speculative Development
Lacks any pre-leased or pre-sold units. During weak or recovering market periods, has a very difficult time obtaining capital.
Junior Creditors
Lenders whose positions are subordinate to senior lenders, meaning that they are only paid have seniors have been paid in-full.
Real Estate Owned (REO)
Liability that appears on a lender's balance sheet when they foreclose on and take back a property for which they have a loan. The loan disappears on the lender balance sheet and the property is added as a liability.
Recourse Loan
Loan in which the lender is entitled to seize a debtor's personal assets not related to the property in order to satisfy their claim.
Excess Loan
Loan made by a state charter or national bank to an individual that is over the loan lending limit established by law. State banks are typically limited to 10% of their capital to a single borrower, while national banks are limited to 15%.
Superfund Law
Makes new owners liable for environmental damages and violations, regardless if it occurred during their ownership.
Rate Cap
May be negotiated by a borrower to set a ceiling on how high the variable rate can rise.
Speculative ("Spec")
Means there are no units under contract prior to the start of construction.
Linneman Real Estate Index (LREI)
Measures capital market balance by calibrating commercial real estate debt relative to the ultimate driver of space demand, economic activity (proxied by GDP). Rises when outstanding mortgage debt rises more rapidly than the economy's growth and declines when money is tight relative to economic growth. Is near 100 when supply and demand conditions for real estate capital are in rough balance.
Net Absorption
Measures the difference between total newly-occupied square footage and the total square footage vacated during the same time period. Basically, how much vacant supply was leased.
Loan Restructuring
Method that is applied to prevent default. A loan is restructured so that it can once again be current and ultimately be repaid in full. Is often determined based on the condition of the market, the borrower's reputation as an operator, and the relationship between the borrower and lender. Implementation often involves a loan modification.
Interest Calculation Bases: Actual/365 (aka 365/365)
Monthly rate is calculated by taking the annual interest rate, dividing it by 365 days, and then multiplying that daily rate by the number of days in the current month. During leap years, 366 days are used, resulting in a slightly higher rate.
Interest Calculation Bases: 30/60
Most Prevalent Takes the nominal interest rate and divides it by 360 days to get the daily equivalent rate, then multiplies the daily rate by 30 to get the monthly rate.
Unlevered Cash Flow =
NOI after the deduction of capital and leasing costs. "Unlevered" reflects the lack of impact of any debt financing in the calculation of cash flows. Also known as adjusted NOI. Unlevered NOI = NOI + Tis + LCs + CAPX
Pre-Leasing
Obliges the tenant to sign a pre-agreed lease if the building receives a certificate of occupancy by a specified date, is built in accordance with agreed-upon design specifications, and has an agreed-upon tenant profile. Mitigates some of the uncertainty of future cash flows and tenant credit risks. However, owners usually must offer discounted rents and cannot take advantage of the market if market rents rise. Less relevant for multifamily.
Balloon Payment
Occurs during the final month or quarter of the amortization schedule and is equal to all remaining principal owed at the end of the loan term.
Deficiency Claim
Occurs when the value of a property is insufficient in repaying the entirety of the creditors' outstanding debt.
Property Title Search
Offers information on a potential investment property, its owner, prior owners, and competing ownership claims.
Funds from Operations (FFO) =
One of the non-audited measurements used to better reflect the real time "free cash flow" of real estate companies and their ongoing operations. Reflects funds from operations available to equity owners on a pre-income tax basis. FFO = (NI Before Extraordinary Items) + (Minority Interests in Operating Partnerships (OPs)) +/- (Loss (Gain) on Sale of Assets + Depr. [Including OP] and Amort.) + (Impairment on Assets AFS)
Residual Split
Only the profits in excess of the preferred return distribution.
Fixed Operating Expenses
Operating costs that do not change with the strength of the market or the property's vacancy levels (i.e. Insurance, property taxes, etc.).
Disposition
Outright sale of the fee simple ownership interest of a property.
Corporate General and Administrative (G&A) Expense
Overhead expenses such as corporate salaries, corporate office leases, and fees from accountants and lawyers.
New Value Expectation
Overturns the Absolute Priority Rule. Provides those who have provided credit to a firm in Chapter 11 precedence in repayment to Senior Lenders.
Pari Passu
Pro Rata/Proportionate to the amount invested.
*IMPORTANT FORMULA* Build to X% Return^1 =
Projected Stabilized NOI/ Projected Total Costs
Real Estate Cycles
Prolonged periods of supply and demand imbalance which almost always last for years. Real Estate assets tend to gravitate towards supply-demand equilibrium, although it is virtually never truly met.
Fixed Charges Ratio =
Property NOI divided by all fixed charges incurred annually. Includes all debt service payments as well as other fixed charges the borrower incurs, such as ground lease payments, operating lease payments, and payments on unsecured debt. Fixed Charges Ratio = Expected Annual NOI/(Debt Service Payments + All Other Fixed Costs)
Stabilized Property definition and Stabilized Property =
Property's NOI is flat or growing relatively smoothly year-over-year. Property's NOI is indicative of the asset's long-term future performance. Stabilized Property Value = Stabilized NOI/Cap Rate
Taxable REIT Subsidiary (TRS)
Provide services to tenants or third parties such as landscaping, concierge, cleaning, etc. Provide new earnings growth opportunities and allow REITs to more effectively compete with other real estate owners.
Contingency Reserve
Provides a separate source of capital as an insurance fund in the event of an unexpected and possibly costly event occurring during the development stages. Complicated developments or redevelopments on older properties generally require larger reserves.
Appraisal
Provides a valuation based on comparable sales or income capitalization. However, appraisals are lagged and always wrong. At best, they are informed and unbiased professional estimates. Are over-stated in hot capital markets and under-stated in cooler markets.
*IMPORTANT FORMULA* Rent per GSF =
Rent per LSF * (1 - Loss Factor %)
*IMPORTANT FORMULA* Stabilized NOI per GSF =
Rental Revenues per GSF - Operating Costs per GSF
Title Surveys
Reports provided by the title companies through public records research
Reassesment
Requested when a property owner believes that the site is being over-assessed. Is the first step in pursuing a reduction in property taxes.
Primary Real Estate Sectors:
Retail, Office, Residential, Industrial
Loan Covenants
Rules and actions specified in the loan contract that highlights requirements which the borrower must meet as part of the loan agreement. Violating these covenants may result in financial penalties or the acceleration of the loan. Lends will attempt to impose as many covenants as they possibly can.
Positive Leverage
Simply means that the property cash flow yield percentage is greater than the annual interest rate paid to the lender.
Negative Leverage
Simply means that the property cash flow yield percentage is less than the annual interest rate paid to the lender.
Refinancing (Refi)
Simply put, is the replacement of one debt facility with another. May allow a borrower to take a loan larger than the outstanding balance of the current loan by withdrawing cash from the equity of a property.
Interim Income
Small portions of income that a new property may generate while still under construction. In some cases, this may help with the funding of the property's development.
*IMPORTANT FORMULA* Stabilized NOI in Year X =
Stabilized EBITDA - CAP, Tis, and LCs
Income Multiple Analysis
Standard valuation method which estimates a property's value by multiplying next year's stabilized NOI by the price-to-NOI multiple for which comparable properties are selling today.
Absolute Priority Rule
States that no junior creditor will receive consideration until senior creditors are paid in-full.
Catch-Up Provision
Stipulates what the split will be, if a split is used. The lower the share of profits promised to the sponsor, the lower the risk to the investor that they may end up over- allocating fund profits to the sponsors.
Total Operating Expenses =
Sum of reimbursable and non-reimbursable expense. = Reimbursable Expenses + Non-Reimbursable Expenses
Pass Through Entity
Tax liability is calculated for the property and is literally passed through to individual partners in a limited partnership entity.
"Pencil"
Term used for proposed developments that indicates whether a new project can show a sufficient level of return relative to risk.
Trophy Building
The absolute best properties in a market place. Usually constitute the top 2%- 3% of Class A properties.
Expropriation
The action by the state or an authority of taking property from its owner for the benefit of the public.
Loan Constant
The amount calculated for the constant monthly or quarterly payment factor. Assumes that the loan will be completely paid off over the course of the loan term.
Term
The amount of time over which principal can remain outstanding. Short-term mortgage debt is usually 3-5 years while long-term mortgage debt is 10-30 years.
Debt Service Coverage Ratio (DSCR) =
The annual NOI of the property divided by the annual debt service payment inclusive of both principal and interest. Generally, DSCR for secured first mortgages must exceed 1.2x. DSCR = Expected Annual NOI/Total Annual Debt Service Payment* *Interest and Principal
Ground Lease
The building is owned by the property owner, but the land title on which the asset sits belongs to a third-party land owner. The terms on this lease type are usually very long. At the end of the lease term or in the event of a lease violation or default, the land owner is typically entitled to ownership of the building. This form of lease if relatively rare and have simple payment structures.
Levered Cash Flows
The expected pre-tax and post-tax cash flows exclusively to equity. To calculate cash flows on equity, incorporate debt, tax liabilities, and tax depreciation into analysis.
Pool Default Rate
The expected rate of default of mortgages within an SPE.
Replacement Cost
The hypothetical amount it would take to acquire the land and construct the exact same property today. This includes the necessary TIs and LCs required to attain the exact same tenant profile.
Margin Call
The immediate requirement for a securities holder to produce a significant amount of cash to offset the loss of value in accounts in which they purchased securities using borrowed funds.
Base Rent
The initial rent for a space
Loan Acceleration
The lender's ability to demand full repayment of a loan prior to maturity if a loan covenant is violated.
Loan-to-Value (LTV) Ratio =
The principal amount of the loan divided by the estimated property value. Reflects how much equity cushion the lender believes they have before the loan is underwater. For first secured mortgages, LTV is usually 50%-70%. LTV = Principal on Loan/Estimated Property Value
Value Engineering
The process of reducing construction costs where possible without destroying the value of the final product.
Fee Simple Ownership Interest
The purchase of both a building and its associate land. Is by far the most common purchase type associated with real estate transactions.
Capital Appreciation
The return a property owner earns as a buildings value increases or decreases.
Easements
The right to do something with a property. Appurtenant easements may allow someone to cross through a property for transportation, ingress, or egress purposes.
Financial Modeling
The systematic projection and analysis of projected outcomes for an investment. Is used as a tool in evaluating risks and opportunities. Detailed model provides a microscopic view of the financial elements of a property.
How are the three main financial statements connected?
The three main financial statements show separate views, and together they create a whole picture of a company's financial health. For example, the Income Statement closes with a net income figure that appears on the Cash Flow Statement as an addition to cash flow from operations. The Cash Flow Statement's beginning cash balance comes from the Balance Sheet for the prior period. The Cash Flow Statement's ending cash balance becomes the cash asset on the current period's Balance Sheet.
Gross Absorption
The total amount of square footage that tenants newly occupy over a given period of time.
Straight-Lined Rent Adjustments
The total rent over the lease term is divided by the term, and the resulting average rent is used as the reported rent each year.
Base Year
The year that the lease is signed
Net Operating Income (NOI)
Total Operating Income less total operating expenses. Summarizes the property's ability to generate income, irrespective of capital structure. Also known as "the line." Total Operating Income - Total Operating Expenses
Negative Amortization Loan
Type of loan in which the principal owed rises in each successive month.
Debtor in Position (DIP) Finacing
U.S. Bankruptcy Laws allow the defaulting borrower to subordinate existing debt claims to new debt which is taken on to operate the business while it attempts a successful reorganization.
Greenfield Land
Undeveloped land, such as farm or pasture.
CAPX inefficiencies
Unexpected, expensive CAPX (i.e. a new roof) needs can occur at any time Replacement Reserves are regularly funded into a dedicated account (minimum accounts required by a creditor) In weak markets, CAPX may be restricted to essential repairs
Pre-Tax Levered Cash Flow
Unlevered cash flow minus total debt service (interest payments and any amortization). = Unlevered Cash Flow - Loan Payments - Interest Payments
Cash Flow Cap Rate
Used as an alternative valuation metric to the NOI cap rate. Is a proxy for property income yields after normalized reserves are deducted for Tis, LCs, and CAPX. Determined by discounting the property NOI-based cap rate by an approximated percentage of NOI set aside for reserves. This metric is considered the truest, most pure measure of a property's unlevered pre-tax net income.
Loan-to-Cost (LTC) Ratio
Used for construction loans as the parameter for the largest allowable loan size. Unlike with LTV, construction lenders are providing funds towards an approved budget of the costs of development and construction, not the appraised value or sale price of the property upon construction completion. Typically, LTC ranges from 55%-70%, depending on the project, market condition, and strength of the sponsor. LTC = Principal on Loan/Estimated Total Cost of Construction
Normalized Reserves
Used for estimating adjusted NOI and are subject to interpretation from analyst to analyst. Applies to capital spent on CAPX, Tis, and LCs which is deducted from NOI.
Residual Land Valuation =
Used to calculate what a developer can afford to pay for a land site as a function of the market environment and his required expected return. Is a back solving technique that makes land cost an unknown variable against the projects required expected return. Solving for Maximum Land Cost: Required Return = NOI/(Soft Costs + Hard Costs + Maximum Land Cost)
Exit Cap Rate =
Used to estimate the resale value of a property at the end of the holding period. Is the final year's NOI divided by the property's terminal value. Exit caps are usually higher than going-in caps because the property has aged and may be relatively less competitive. Exit Cap Rate = Final Year NOI/Property's Terminal Value
Going-in Cap Rate
Used when deciding whether to purchase a property. Is the NOI from last 12 months prior to acquisition divided by purchase price. Going-In Cap Rate = NOI/Purchase Price
Purchase Cap Rate
Used when purchasing a non-stabilized property. Purchasing when income is low and exit cap is meant to be used on a stabilized property
Loan Modification
Usually a part of the loan restructuring process. Typically, this involves restructuring the interest rate and/or the amortization term to reduce the monthly debt service payment to be more affordable to the borrower.
Preferred Return ("Pref")
Usually an IRR based hurdle rate of about 7-11% annually
Gross Development Profit Margin =
Utilizes both going-in and going-out cap rates. A meaningful profit margin is why developers accept associated development risks. Measures the projected value created relative to the total expected costs of the development project. GDPM = (Expected Going-In Cap/Expected Going-Out Cap) - 1 (Expected Going-In Cap/Expected Going-Out Cap) -1 = (Expected Value at Sale/Expected Cost) -1
"The Money"
Vernacular used for the investors who provide the bulk of capital invested into a fund.
Syndicates
Very small single-transaction investment group. Historically, provided debt and minor cash equity investment for the purchase and development of properties.
2030 Percentage Growth Forecast Leaders (6):
Walla Walla, WA Hinesville, GA Carson City, NV Valdosta, GA Rapid City, SD Charlottesville, VA Top 10 2030 MSA Growth is Driven by where: Percentage Growth MSAs are forecasted to increase in population by 1.5 million by • People want to work and play • Firms find it efficient to produce • Necessary building approvals are easy to obtain • Potential growth can be accommodated • Additional "wild card" factors
Cure
When a firm overcomes its delinquent status by making all missed payments current and avoids default.
Delinquent
When agreed-upon debt service payments have ceased being made when they're due.
Loss Carrying-Forward
When taxable income calculations yields a negative amount (a loss), any unused loss amounts from one year can be carried forward and applied to the subsequent year.
Variable Operating Costs
Will be lower when there are higher rates of vacancy. With fewer tenants, certain operating costs (I.e. utilities) will be lower. In addition, certain costs can be reduced by handling them internally (i.e. Mowing the lawn yourself).
*IMPORTANT FORMULA* Building NOI DCF =
Year X Terminal Value = Year X (Property NOI + Ground Lease Payment)/Terminal Cap Rate
Gross Development Profit Margin Example
You have finished a project with a total development cost of $10,000,000. You expect to sell the project for $12,500,000, creating $2,500,000 in value. Thus, your gross development profit margin for the project is 25%. GDPM = ($12,500,000/$10,000,000) - 1 = 25%
Gurantees
ender may require the borrower to commit to certain events such as construction completion or leasing to a specific level of occupancy. Failure to do so may result in financial penalties or recourse.
Hard Costs
osts relating to construction, such as labor and raw materials. The largest hard cost is the cost of construction. Graphically, tends to be shaped like a bell curve and accumulate over the life of the project in the shape of an S curve. Costs are low during the early stages, build up rapidly, and top off in the final stages of the project.
Replacement Rent =
s a function of the replacement costs, risk premiums, and adjustments for vacancies and associated costs. Helps with determining the income viability of a new project. Can and should be applied on a Gross and Leasable SF basis. Replacement Rent per GSF = (Build to Return * Expected Total Cost) + Expected Operating Costs Replacement Rent per LSF = Replacement Rent per GSF * (1/(1 - Loss Factor)) * (1/(1 - Vacancy))
Triple Net Lease (NNN)
tenant pays all operating costs, property taxes, and base rent and escalations.
Calculating Value of Other Income
• "Other Income" may include income generated from parking, Fees from Non-Combined Affiliates, and Other sources of additional income. • To find the total Value of Other Income, sum the value of each source of Other Income multiplied by its respective multiple. Require the firm to value the existing leases on a newly acquired asset and reflect and above or below market differences, account for goodwill and other intangible assets from acquisitions, and reflect retirement of tangible long-lived assets and the costs of this retirement.
Questions to expect from a Loan Officer (5)
• "What is the money for?" • "How much equity is ahead of my loan?" • "How large of a loan do you want?" • "When exactly do you need the money?" • "When and how do I get paid back?"
Impact of Sponsor Promotes: Value-Add
• A 10% cumulative preferred return to investors • The return of investor capital • 50% of remaining cash flows go to the general partner's "catch up," until the general partner has received 20% of all profit distributions -Does not include the return on their invested capital • After the profit distribution, profits are split - 80% to "the money," 20% to the fund sponsor
Impact of Sponsor Promotes: Core Plus
• A 9% cumulative preferred return to investors • The return of invested capital • 50% of remaining cash flows go to the general partner's "catch up," until the general partner has received 10% of all profit distributions -Does not include the return on their invested capital • After the profit distribution, profits are split - 90% to "the money," 10% to the fund sponsor
Primary Costs of a Repayment Penalty
• A percentage of the loan's outstanding balance -Typically, a declining percentage amount the longer the loan is outstanding • Defeasance • Yield Maintenance
Common Issues Related to Real Estate Ethics
• Bribes • Favoritism • Environments that foster immoral cultures and practices • Perverse Incentives • Conflicts of Interest
Tax Status Characteristics of a C-Corp
• Can retain more cash flow for growth • Pays corporate taxes • Possesses a simple corporate structure • No limitations on the types of businesses performed
Common Positive Covenants (3)
• Deposits: Lender may require the borrower to keep a minimum balance of their operating or corporate checking accounts with the lender's bank. • EBIT, Cash Flow, or NOI: Lender requires the property maintain a minimum level of EBIT, Cash Flow, or NOI. This provides the creditor with a cushion and a check on the status of their collateral associated with the property loan. • Leases: Lender may require the borrower to provide copies of all new pending leases prior to their execution. Helps ensure the debtor's leasing execution is consistent with the business plan presented when the loan was originated.
Common Exit Methodologies (5)
• Disposition • Refinancing • Like-Kind Exchange (1031 Exchange) • Exchange for Public Company Shares • Going Public (IPO)
Forecasting Variables for Forecasting Corporate-Level Net Income (8)
• Existing Properties Revenue Growth • Acquisitions, Developments, and Rates of Return • Dispositions During the Period • Fees from Non-combined Affiliates • EBITDA • Debt Service Expense • Amortization, Depreciation, and Impairments • Minority Interest
Common Reasons for Exiting (4)
• For developers, it is a matter of competency. Competency is in creating, not operating, properties. • Altering your risk-reward profile. If you are unwilling or unable to deal with the complexities, costs, and challenges associated with a specific property, you will want to exit. • For opportunistic investors, there is a desire to exit a property once value has been added. • "Old Fashioned" reasons such as properties related to an inheritance, divorce, or dissolved partnership.
Differences Between Public RE Firms and RE Private Equity Funds
• Investments in private equity funds are less liquid • Private equity funds seek higher returns • No investment minimums for public RE firms -Provide a real estate investment opportunity to all types of investors • Investors in public RE firms typically own both the real estate assets and the management team
Components of Mezz Financing (4)
• Junior Debt: Whether holding the second, seventh, or another unsecured position. • Preferred Equity: Has seniority to common equity, but subordinate to senior debt. • Convertible Debt: Creditor holds the debt but has the right to convert it into common equity at specific terms. • Participating Debt: Creditor receives an annual interest payment along with a property's income above a specified level.
Tax Status Characteristics of a REIT
• Large dividend payments • Does not pay corporate tax • Highly dependent on equity specialists in raising growth capital • Numerous operating restrictions
Linneman Construct Cost Index (LCCI) Composition
• Lumber (5%) • Concrete (5%) • Gypsum (10%) • Iron & Steel (10%) • Labor (50%) • Land (20%)
Investment Return Profiles: Unlevered Core (NACREIF)
• Medium Transparency • Amount of capital put to work depends on the availability of desirable investments and the ability to win control of those investments • Offer the greatest investor operating control • Assets are easy to understand and the most stable from a cash flow perspective • Have less diversification due their focus on stabilized, core assets
Investment Return Profiles: Core Plus
• Medium Transparency • Amount of capital put to work depends on the availability of desirable investments and the ability to win control of those investments • Significant investor operating control and less cash flow volatility • Assets are easy to understand and the most stable from a cash flow perspective • Aligned investor-manager interests due to de facto promote structures
Investment Return Profiles: REITs (NAREIT)
• Most liquid investment type • Are the most transparent investment vehicles oRequired to adhere to rigorous SEC guidelines and reporting standards. • Offer investors no operating control but allow easy exit • Aligned investor-manager interests due to de facto promote structures
Guidelines of a 1031 Exchange
• Must be certain that the new property is being held for investment or productive use. • The new property cannot be acquired with the intent of resale after a short time period. • Items exchanged must generally be in the same business. -Cannot sell a property and buys stocks and bonds in an energy company - "Nature and character of a property, not its grade or quality." • Must be within the United States
Basic Regulatory Requirements of Obtaining REIT Status
• Must have a minimum of 100 shareholders during the second year of operations • No more than 50% of REIT shares can be owned by five or fewer investors • At least 75% of gross income must be derived from real estate related sources - An additional 20% must be either from these real estate sources or other forms of income such as dividends and income from non-real estate sources - No more than 5% of income can be derived from non-qualifying sources (i.e. service fees or non-real estate business) • At least 75% of total assets must be invested in real estate • Cannot own more than 10% of a corporation with the exception of another REIT, a TRS, or a QRS - The same applies to stock ownership of another corporation where the stock value constitutes 5% or more of total assets • Must pay at least 90% of taxable income as an annual dividend
Cash Flow Cap Rate Discount Factors (4) =
• Office Space: 0.68 • Apartment Space: 0.83 • Industrial Space: 0.69 • Retail Space: 0.64
Common Market Frictions
• Permits and Regulations • Production and Information Lags • Time • Increased Vacancy Rates
Common Negative Covenants (4)
• Prepayment Penalty: Pre-determined cash amount a borrower must pay if they pay off a fixed-interest loan prior to maturity. Protects lenders from massive prepayments if interest rates drop. • Distributions: Limits the amount of cash distributions a debtor can provide equity holders. Requires debtor to set aside reserves for future interest payments and future CAPX needs. • Operating Restrictions: Sets an operating level below which a property cannot fall without penalty or loan acceleration. Prevents borrower from signing below-market leases which would deteriorate the value of the lender's collateral. • Additional Debt: Prevents the borrower from obtaining additional debt financing without the lender's approval.
Depreciable Life Spans
• Residential Properties: 27.5 Years • All other Property Types: 39 Years
Firm Productivity Varies Across Locales for Several Reasons (4):
• Skills and education of the local population • Accessibility to markets and transportation nodes • Impact of local public finances (taxes and expenditures • Agglomeration Economies
Risk Premium Spread Over Treasury Yields
• Subject to the level of investors' fear and greed • Risk premium margin over 10-Year T-Bonds increases when investors seek safety in government bonds (drives bond prices up and yields down) Margin decreases when investors perceive a decline in risk associated with real estate cash flows (investors move from government bonds into real estate positions) Note: Reported NOI does not always reflect major capital expenditures and leasing commissions.
Tax Status Characteristics of a Partnership
• Tax Liability without a profit distribution • Does not pay corporate tax • Cumbersome governance structure
Characteristics of a Capital-Intensive Industry Transition
• Transition period of 20-30 years • Emergence of a "visionary" leader within the industry or an individual firm • Competition wars ultimately resulting in consolidation of capital • Capital requirements needed to meet rapid growth • Regulatory changes • Excess capacity
Financial Accounting Standards 141/142/143 Adjustments
• Value the existing leases on a newly acquired asset to reflect any "above market" or "below market" differences • Account for goodwill and other intangible assets from acquisitions • Reflect the retirement of tangible long-lived assets and associated retirement costs
Common Traits of Successful Ownership in a Capital-Intensive Industry
• Visionary leadership and the ability to sell that vision • Low long-term capital costs relative to competitors • Low overhead relative to competitors • Enhanced revenue opportunities relative to competitors • Successful risk management • Operating efficiency
Primary Questions in Corporate Real Estate Decision Making (4)
• What type of space do I need? • Where should I locate? • How much space do I need? • Should I own or rent?
LREI Metrics
• ~ 100: Rough balance in supply and demand for real estate capital • < 100: Indicates an increased demand for supply of real estate capital • > 100: Indicates an excess of supply of real estate capital
*IMPORTANT FORMULA* Differential After-Tax Present Value of Profitability of leasing versus self-ownership: ∆π =
∆π = πL - πO = (1 - t) V [(r + αe) M -gN] - (D + A) Where: ∆π = Differential After-Tax Present Value Profitability πL = Present Value of Leasing πO = Present Value of Self-Ownership t = The Corporate Tax Rate V = The Property Value r = The Rate of Return on Core Corporate Operations αe = The corporate owner's proportional operating costs relative to landlords M = The company's Core Operation Valuation Multiple g = The Landlord's Expected Rate of Return N = The Real Estate's Cash Flow Multiple D = The Present Value of Tax Savings Associated with the Depreciation Allowance Provided to Owners of Corporate Real Estate A = The Present Value of the Expected After-Tax Appreciation on the Corporate Real Estate
Most Prevalent Risks of Foreign Real Estate Investment
1) High political risk 2) High economic risk 3) The absence of markets with meaningful exit opportunities
Common Risks
1) Operating Expenses 2) Vacancy 3) Natural Disaster 4) Uncertain Leases and Expirations 5) Liquidity Risks
Economic Terms of a Lease
1) Rent 2) Marketing Budget 3) Operating Expenses 4) Property Tax and Insurance Expense 5) HVAC 6) Security and Property Maintenance 7) Tenant Improvements 8) Tenant Improvements 9) Free Rent 10) Capital Costs 11) Rent Cost
Non-economic Terms of a Lease
1) Signage 2) Going Dark 3) Hours and Days of Operation 4) Length of Lease 5) Expansion Rights 6) Usage Restrictions 7) Sublet Rights 8) Location Assignments 9) Tenant Mix 10) Parking 11) Recourse and Security Deposit
*IMPORTANT FORMULA* Taxable Income =
= NOI - Depreciation - Interest
*IMPORTANT FORMULA* Excess Tax Shelter =
= Taxable Income * Tax Bracket Rate
*IMPORTANT FORMULA* Depreciation on TIs & CAPX =
= Total TIs + TOTAL CAPX
Credit Loss definition
A.k.a "Bad Debt." Is deducted from operating income to reflect the anticipated non-payment of rent and other revenues. For quality properties, makes up 1-2% of expected gross income. Strongly correlated with the strength of the market and the credit-worthiness of a property's tenants.
Reimbursements
A.k.a. Cost Recoveries. Are specified in each tenant's lease and determines the split of specific expenses between the landlord and tenant.
Fixed Rent
A.k.a. Rent Abatement. Occurs when no rent is paid during the first few weeks, months, or years of the lease. In weak markets, may be preferred to discounted rents in order to keep rents closer to their typical rates.
Capital Reserves
A.k.a. Replacement Reserves. Separate account whose funds are held to readily deploy capital when needed. Regular funding is required by lending on mortgaged properties.
Retail Properties: Overview
Come in many different sizes and forms, with the primary objective being maximizing sales from individual consumers. Provide points of purchase for physical goods and places to receive services. Most successful when conveniently located and accessible, have the right product in stock at the right time, display services in an attractive manner, and removes all barriers that could deter a potential consumer from making their intended purchase
CBD Ranking Structure Class C
Compromises of the remainder of properties. Generally are the lowest quality buildings in the market with significant needs for renovations and capital expenditures. Suffer the most during market downturns
Net Lease
Contractual agreement where the tenant pays some or all of taxes, insurance costs, and maintenance costs in addition to rent. Shifts the risks associated with such expenses from the landlord to the tenant.
Full Service Hotels
Includes urban CBD and resort properties, which may carry the flag of a high-price point operator (i.e. The Four Seasons) or a mid-point operator (i.e. Marriott). Provide room service, restaurants, banquet space, convention services, and food and beverage services. May also provide spas and limited retail.
Superflat Floors
Increasingly required to have strict transverse and longitudinal tolerances
Local Partners
Individuals who live in the foreign market in which a firm is investing. May be employed by a firm so as to share their wealth of knowledge and expertise relating to the local market. Can also introduce a firm to an immense network of professional relationships.
Tenant Improvements (Tis)
Interior space physical improvements made to make tenant space habitable, useful, and pleasant. Who pays Tis and how much is subject to lease agreements, with terms often being heavily influenced by the current market condition.
Expansion Rights/Options
Lease prescribed option that gives a tenant the option to satisfy growth at the same location. Option can be sold mid-lease term with the new space usually adjacent to the tenant's current space. Is especially common with large office and warehouse properties.
Radius Restrictions
Lease term that prevents tenants from opening other stores and locations within a certain distance. Protects the landlord from the tenant potentially cannibalizing sales at their center.
CBD Ranking Structure: Class B
Less well-located and are smaller, older, and provide fewer modern amenities. Often are of a lesser design.
Central Business District (CBD) Space
Office space usually located in a city's central corridor. Has a Highrise form with a "Main & Main" orientation relation to the transportation network. Usually tied to historic and government nodes.
Limited Service Urban Hotels
Often boutique properties. Distinguishing feature is that they are smaller and do not offer amenities such as room service, restaurants, banquet service, and convention space. Has limited overhead and tends to stabilize operating income. Greatest challenge is effective marketing.
Brownfield Land terminology
Parcels of land that had an industrial use and may be environmentally impaired.
Flex Building
Property with an easily convertible structure. Common construction technique is a concrete slab structure that tilts up to finish the building. Do particularly well in strong markets, but suffer during downturns.
Capital Items
Property's capital and leasing costs. Are a collection of property-related expenditures critical to attracting new tenants, and to maintain both a high property operating standard and the integrity of the physical plant.
Stacking Plan
Provides a visual representation of a building's leases. Notes tenant name, locations and square footages leased, lease expiration dates, and current rental rates.
Insurance
Purchased to protect property from natural disaster, tort liability, theft, fire, etc. Some leases may require tenants to obtain individual leases for the interior of their space to cover potential liabilities such as damage to inventory, customer accidents, etc.
Floor Area Ratio (FAR)
Ratio of building's above-grade gross floor area (Vertical and Horizontal) to the area of the lot upon which the building is constructed. Outside of the U.S., the term Floor Space Index (FSI) is used. FAR = Gross Floor Area/Land Area
The Real Estate Risk Spectrum: Opportunistic Funds
Re-positioning of ailing properties; Ground-up development; Emerging market investments; Buying entire companies with owned operating assets Target Levered IRR: 16%+ Leverage Employed: >70%
Physical Occupancy
Refers to space that is physically occupied, regardless if it is generating rent income. For example, a bankrupt tenant still occupies space even though they aren't paying rent.
Economic Occupancy
Refers to the space currently generating rent
Common Area Maintenance (CAM) Costs
Refers to the upkeep of areas and services that benefit all tenants. Are not tenant specific. Examples include cleaning hallways, security, and parking lot maintenance.
CBD Ranking Structure: Class A
Relatively new and well-located property that possesses a modern HVAC system, electrical systems, and quality architecture. During downturns, are more resilient and better-leased as tenants move from less-quality buildings with the decrease in rental rates.
Net Rent
Rent after all operating costs are paid off
Usage Restrictions
Restrictions relating what a tenant can use their leased space for a specified in the lease.
Gross Potential Rental Revenue (GPR)
Revenue that you would receive if the building's leasable space was 100% occupied.
Economic Risk
Risk that macroeconomic circumstances will result in a loss on an investment or business activity. Includes factors such as inflation, exchange rates, new government regulations, and other decisions the adversely impact profits.
Political Risk
Risk that political events, decisions, or conditions will significantly affect the profitability of a business actor or the expected value of an economic position.
Currency Risk
Risk that, in the event of a sufficiently large adverse currency movement, an investment's dollar performance will be destroyed. Firms with try to mitigate this risk through currency hedging and underwriting currency erosions that are expected to occur over an investment's lifetime.
Loss Factor
The difference between gross and net leasable square footage. Measures a property's efficiency, with a high loss factor indicating less efficiency. Loss Factor = GSF - LSF
Stand-alone Centers
have a single store such as a Walmart, Target, Kroger, etc. with no other stores
Extended Stay Hotels
Have larger rooms, small kitchens, and provide limited services. Are designed for individuals planning to stay for a week or longer.
Base Rent Escalation
How, if at all, rent changes during the life of the lease. May change based on inflation metrics, with base rent growing each year proportionate to changes in the consumer price index (CPI)
Outparcels
Located near a larger retail center. Tenants are usually along the lines of a fast food restaurant or local bank.
Infill Land
Located primarily in urban areas, is generally vacant or undeveloped, and is surrounded by developed land parcels. In many cases, has been developed but is currently vacant.
Currency Hedge
A transaction used to protect against adverse currency movements prior to closing. Usually have a short duration and are relatively cheap.
The Real Estate Risk Spectrum: Core Plus Investments
Acquisition of Core-type property that needs some relatively minor enhancement; sub-market can be secondary Target Levered IRR: 9-12% Leverage Employed: 30-60%
The Real Estate Risk Spectrum: Core Investments
Acquisition of well-occupied, stable cash-flowing office or apartment buildings in an established sub-market Target Levered IRR: 7-9% Leverage Employed: 0-30%
Non-Compete Clauses
Agreement between a tenant and landlord in a retail lease that ensures the tenant that the landlord will not lease a similar business to the tenant during their lease term. Highlights tenant desire to have businesses that are complimentary, not competitive, to their operations in a retail center. Landlord is incentivized by higher percentage rents.
Co-Tenacy Clause
Agreement between the lease that results in a tenant only leasing within a retail center if other tenants its lease space. Can be problematic if several tenants or one key tenant go bankrupt, go dark, or decide not to renew their leases.
Percentage Rent
Also known as overage and is unique to retail rents. Provides additional rent, that specifies the percentage of the tenant's gross sales revenue that the landlord receives in addition to base rent and escalations. Helps align tenant and landlord interests.
Net Effective Rent:
Annual rent net of unrecovered maintenance/operating costs, amortized free rent, amortized leasing commissions, and amortized values of tenant improvements. Net Effective Rent = Gross Rent + Cost Recoveries - Maintenance/Operating Costs - Amortized Free Rent - Amortized Tenant Improvements - Amortized Leasing Commissions
Depreciation
Cost-allocation mechanism that provides a multi-year schedule on which property owner can deduct the total cost of an asset for annual income tax calculation purposes. Is essentially a fiction that can only be seen on financial statements.
Common Area Maintenance (CAM) Costs
Costs associated with complimentary tenancy, design, and shared amenities. Are typically reimbursed, at least in part, by the tenants, as the uniform upkeep of shared landscaping, sidewalks, and parking benefits all tenants.
Fixed Expenses
Costs that remain unchanged regardless of a property's occupancy level. Includes expenses such as insurance costs and property taxes.
Variable Expense
Costs that's total amount is dependent on a property's level of occupancy. Applies to operating expenses such as utilities and gas.
Total Depreciation =
Depr. From Purchase + Total Depr. Tis + Total Depr. CAPX
Assessed Tax Value
Dollar value assigned to a property to measure applicable taxes.
The Real Estate Risk Spectrum: Value-Add Investments
Significant value enhancement needed through operating, re-leasing, or re-development Target Levered IRR: 12-16% Leverage Employed: 60-60%
Inline Stores
Smaller stores that make up unanchored properties. If a retail center has anchors, these businesses are complemented by the larger retailers and their associated consumer traffic.
Heavily Manufacturing Facility
Special purpose properties that can be thought of as pieces of equipment rather than real estate (but for location dimension). Difficult to establish an alternative use without substantial renovation.
GPR =
TOTAL LSF * Avg. Base Rent PSF
Gross Square Footage (GSF)
Total area of the building, usually measured from inner wall to inner wall, with no deductions for obstructions or non-leasable space GSF = Net Leasable Area/ Rentable Square Feet
Chevron Corner Design
V-shaped design that provides eight or more corners by notching an otherwise rectangular building. Improves the efficiency of a property's design.
Bulk Warehouses terminology
Very large buildings that are located near major transportation hubs for ease of truck access. Typically has a simple design and are face with the challenges of efficiently processing large volumes of trucks in and out of the property.
Capital Shortage Myth
• Common belief that non-U.S. real estate markets generally experience capital shortages -In reality, markets such as London, Paris, and Amsterdam are no different from markets such as New York or Los Angeles in terms of capital sourcing • Capital Cycle (10 Year Basis) - Too little capital available for1-2years -Too much capital available for 2-3years - For the remainder of the cycle, supply and demand for real estate capital is roughly in balance
Retail Properties: Community Retail Centers
• Generally, 150,000-350,000 sq. ft. • Have several anchors (usually a supermarket or drug store) as well as several specialty stores (i.e. Foot Locker) and smaller inline stores • Can be laid out as a single center or as 2-3 contiguous strip centers • Located on a local artery road with excellent ingress and egress. Usually easy highway access
Retail Properties: Power Center
• Has 3-5 "Big Box Retailers" -Walmart, Home Depot, Staples, Fresh Foods, etc. - 30,000-200,000sq.ft. each • Few, if any, inline stores • May contain outparcels • Major problem is that individual retailers are interested in maximizing their own profits, not those of retailers around them
Retail Properties: Regional Malls
• Range from 400,000-2,000,000 sq. ft. • Have 2-6 anchor stores (i.e. department stores) - 60,000-120,000sq.ft. each -Draw customers to the center and compliment inlinestores • Inline Stores range from 600-12,000 sq. ft. each and are meant to create an enriching shopping experience • Common areas are large and elaborate -Mall owner bears the financial cost of maintaining them. May be reimbursed based on leasing agreements
