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Glossary
ACCREDITED INVESTOR
In the United States, to be considered an accredited investor, one must have a net worth of at least one million US Dollars, excluding the value of one’s primary residence, or have income at least $200,000 each year for the last two years (or $300,000 combined income if married) and have the expectation to make the same amount this year.
ACTIVE INCOME
Active income is income earned as a direct result of a specific effort. It refers to income received for performing a service. Wages, tips, salaries, commissions, and income from businesses in which there is material participation are examples of active income
ALTERNATIVE INVESTMENT
An alternative investment refers to any investment which is not considered “traditional”. Traditional investments are widely considered to be stocks, bonds and cash.
AMORTIZATION
As opposed to an interest-only loan in which each repayment installment consists only of interest payments with a single lump-sum principal repayment at the end of the loan period, each repayment installment of an amortizing loan consists of both principal and interest.
APPRECIATION
The gradual increase in the value of an owned property over time.
AVERAGE ANNUAL RETURN (AAR)
The Average Annual Return (AAR) calculates the average yearly return on an investment relative to the initial amount invested. Unlike Internal Rate of Return (IRR), it does not account for the timing of cash flows or the impact of market volatility. To calculate AAR, Divide the total profit in the deal by the total investment. Then divide by the number of years you owned the property.
BASIS POINT
A basis point (bps) is a unit that is equal to 1/100th of 1%. In other words one basis point is equal to 0.01%, similarly a 1% change is equal to a 100 basis point change.
CAPITAL
Capital is any financial asset or the value of an asset.
CAPITALIZATION (CAP) RATE
The capitalization rate (also known as cap rate) is used in the world of commercial real estate to indicate the rate of return that is expected to be generated on a real estate investment property. – without taking into account any debt on the asset.
CASH-ON-CASH RETURN
Cash-on-cash return is one of the most widely used metrics in commercial real estate. As the name implies, this metric is calculated by dividing annual before tax cash-flow by the total cash invested in a project.
COMMON EQUITY
Common Equity means that investors have one-to-one (or equal) participation in each dollar invested and any potential profits or losses.
DEBT
An amount of money (obligation) owed by one party (the debtor) to another party (the creditor).
DISTRIBUTIONS
Payments made to investors periodically, typically over the course of a calendar year, either from profits or interest payments.
EQUITY
As it relates to real estate, equity refers to the extent of ownership of an asset. For example, an owner of an apartment building with a mortgage might have equity in the building but not own it outright. The owner(s) equity would be the difference between the market price of the building and the current mortgage balance.
EQUITY MULTIPLE
In commercial real estate, the equity multiple is defined as the total cash distributions received from an investment, divided by the total equity invested. An equity multiple less than 1.0x means you are getting back less cash than you invested. An equity multiple greater than 1.0x means you are getting back more cash than you invested.
FREE CASH FLOW (FCF)
Free cash flow is a measure of a property’s ability to generate cash after paying its operating expenses and setting aside reserves for capital expenditures such as future development, tenant improvements, and leasing commissions.
HARD ASSET
A tangible object of worth that is owned by a business or individual.
INTERNAL RATE OF RETURN (IRR)
In real estate, the IRR, or Internal Rate of Return (IRR), is a financial metric used to measure the profitability of potential investments over its lifetime, that considers the time value of money (the principle that a dollar today is worth more than a dollar tomorrow). The internal rate of return (IRR) is the annual rate of growth that an investment is expected to generate. In multifamily real estate, IRR calculates the rate of return on the property, considering rental income, property appreciation, and the time period of the investment.
INVESTMENT PROPERTY
An investment property is a real estate asset purchased with the sole purpose of earning income. Income from an investment property can be generated through leasing space within an asset or an eventual sale of the asset.
JUMPSTART OUR BUSINESS STARTUPS (JOBS) ACT
LIQUIDITY
Liquidity refers to the ease with which an asset can be purchased or sold. Marketable securities that are traded in high volume tend to be the most liquid, or easy to trade without creating wild fluctuations in price.
LOAN-TO-COST RATIO (LTC)
The Loan-to-Cost Ratio is the ratio of a loan used to help finance a project compared to the total cost.
LOAN-TO-VALUE RATIO (LTV)
A risk assessment ratio that lenders perform when considering a real estate loan. The LTV ratio is calculated by dividing the amount borrowed by the appraised value of the property, expressed as a percentage.
MATERIAL PARTICIPATION
Material participation tests are a set of Internal Revenue Services (IRS) criteria that evaluate whether a taxpayer has materially participated in a trade, business, rental, or other income-producing activity. A taxpayer materially participates if they pass one of the seven material participation tests. However, passive activity rules limit the deductibility of losses when taxpayer participation fails to meet at least one of the seven material participation tests.
MEZZANINE DEBT VS. PREFERRED EQUITY
Mezzanine Debt is generally a loan that is secured by a property and senior to any equity, but junior to the senior loan on the property. Preferred Equity, on the other hand, is an equity investment in the property-owning entity. It is not secured by the property but rather by an interest in the entity investing in (or owning) the property.
NET OPERATING INCOME (NOI)
In real estate, the net operating income, or NOI, represents the annual revenue (or income) generated by an investment property after annual operating expenses. NOI is a before-income-tax figure on a property’s income and cash flow statement, that excludes principal and interest payments on loans, capital expenditures, depreciation, and amortization.
PASSIVE INCOME
Passive income is money earned from an enterprise with little or no ongoing effort.
PREFERRED EQUITY
Typically, in a Preferred Equity investment, all cash flow or profits are paid back to the preferred investors (after all debt has been repaid) until they receive the agreed upon “preferred return.”
PREFERRED RETURN
A Preferred Return is paid to investors before a sponsor receives any share of the cash flow.
PRIVATE EQUITY FUND
A private equity (PE) fund is a collective investment model where money from separate investors is pooled together into a single fund and then used to make investments, most often in various illiquid equity and debt assets.
PRO-FORMA
A financial model often used in real estate to predict future cash flows and total investment returns.
RATE OF RETURN
A rate of return (RoR) is the net gain or loss of an investment over a specified time-period, expressed as a percentage of the investment’s initial cost. When calculating the rate of return, you are determining the percentage change from the beginning of the period until the end.
REAL ESTATE
Real estate includes a parcel of land and any of its permanent structures (buildings, parking lots, etc.).
REAL ESTATE INVESTMENT TRUST (REIT)
A Real Estate Investment Trust (REIT) is a pool of investments in properties which generate income.
RECURRING INCOME
Also known as residual or passive income, recurring income is earned by creating or acquiring an asset that continues to pay of profits regardless of if there is still active work being done to the asset.
REGULATION D
Regulation D permits raises of unlimited amounts from accredited investors without registering a public sale through the SEC, as it’s assumed that accredited investors are financially able to bear the burden of investment decisions without a review by the SEC.
RULE 506(B)
Rule 506(b) is part of Section 4(a)(2) in the Securities Act of 1933, which outlines rules companies or investors must follow to sell securities in a private offering. In a 506(B) offering, a General Partner can raise an unlimited amount of money as long as they do not publicly advertise or solicit investments for the fund. Rule 506(b) permits GPs to raise money from an unlimited number of accredited investors and as many as 35 non-accredited investors. Non-accredited investors in the offering must be sophisticated investors and they must be given additional disclosure documents.
RULE 506(C)
In 2012, Congress passed the Jumpstart Our Business Startups (JOBS) Act to help the U.S. economy recover from the Great Recession. As part of the JOBS Act, Congress lifted the ban on publicizing securities offerings for issuers who raise exclusively from accredited investors. The SEC created Rule 506(c) to outline the requirements investors must meet to participate in those offerings. In a 506(C) offering a General Partner can perform general solicitation and advertising without any limitation on how much capital they can raise. Only accredited investors are eligible to invest in 506(c) offerings, but unlike with the 506(b) exemption, the fund’s GP must take “reasonable steps to verify” that the purchasers are accredited or hire a third party to perform the verification.
SECURED VS UNSECURED POSITION
A secured position in the Capital Stack retains the right to foreclose on a property in the event of a default, or non-performance. Unsecured creditors do not have the right to foreclose on the property, and therefore have less collateral backing their investment claim.
SENIOR DEBT
The “base” of the Capital Stack – Senior Debt is generally secured debt that must be repaid first.
SOPHISTICATED INVESTOR
An individual or an institution with significant market knowledge and experience in both financial and business matters, in addition to significant wealth and income streams
SPONSOR
An individual or firm in charge of finding, acquiring, and managing a piece of real estate.
TENANCY / OCCUPANCY
Occupancy is generally referred to as a percentage of the total square feet or units leased – it is a building’s revenue source.
TERM
The lifespan of a given asset or liability.
THE CAPITAL STACK
The Capital Stack orders the seniority of claims to the collateral and cash waterfall of an entity.
UNACCREDITED INVESTOR
An investor who does not meet the wealth requirements of an accredited investor set forth by the SEC.
UNDERWRITING
Underwriting is the process by which real estate investments are evaluated to determine their viability
YIELD
In the context of commercial real estate, yield refers to the annual cash return on the investment, expressed as a percentage of the investment’s initial cost, or less frequently, its estimated current value.
