1031 Exchange – a 1031 exchange is a swap of one investment property for another. Although most swaps are taxable as sales, if yours meets the requirements of 1031, you’ll either have no tax or limited tax due at the time of the exchange.
Adjustable-Rate Mortgage – when you take out a mortgage, you can either select a fixed rate or an adjustable-rate mortgage. With an ARM, the interest rate can change over the duration of your loan. So, this type of loan is often viewed as risky if you plan to keep a property in your portfolio for more than a few years. With a fixed-rate mortgage, the interest rate stays the same throughout the lifetime of the loan.
Amenities – amenities are features that make a property more attractive, useful, desirable, and/or rentable and are usually included in the sale price or rent calculations.
Amortization – amortization is the process of spreading out payments or expenses over time, depending on whether the amortization is calculated for either a loan or an asset. So, instead of simply paying off interest at the start, amortization allows you to build more equity in your property early on.
Anchor Tenant – A prominent tenant occupying a large proportion of a commercial property and attracts customers and other tenants to the property.
Attornment – attornment occurs when a tenant acknowledges a new owner of the property as their new landlord. In the case of commercial property changing hands, an attornment clause in a subordination, non-disturbance, and attornment (SNDA) agreement requires the tenant to acknowledge a new owner as their landlord and to continue paying rent regardless of whether the property changes hands through a normal sale or a foreclosure.
Balance Sheet – a balance sheet is a financial statement that reports a company’s assets, liabilities and shareholders’ equity at a specific point in time, and provides a basis for computing rates of return and evaluating its capital structure. It is a financial statement that provides a snapshot of what a company owns and owes, as well as the amount invested by shareholders.
Building Classifications – building classifications in most markets refer to Class “A”, “B”, “C” and sometimes “D” properties. While the rating assigned to a particular building is very subjective, Class “A” properties are typically newer buildings with superior construction and finish in excellent locations with easy access, attractive to credit tenants, and which offer a multitude of amenities such as on-site management or covered parking. These buildings, of course, command the highest rental rates in their sub-market. As the “Class” of the building decreases (i.e. Class “B”, “C” or “D”) one component or another such as age, location or construction of the building becomes less desirable. Note that a Class “A” building in one sub-market might rank lower if it were located in a distinctly different sub-market just a few miles away containing a higher end product.
Build-Out – a build out represents the construction activities executed to a commercial building space, to make it functional for a tenant. In this respect build outs can also be considered “tenant improvements” or TIs.
Business Model – The term business model refers to a company’s plan for making a profit. It identifies the products or services the business plans to sell, its identified target market, and any anticipated expenses. Business models are important for both new and established businesses. They help new, developing companies attract investment, recruit talent, and motivate management and staff. Established businesses should regularly update their business plans or they’ll fail to anticipate trends and challenges ahead. Business plans help investors evaluate companies that interest them. source
Cap Rate – short for capitalization rate. Unleveraged initial yield on the investment expressed as the annual Net Operating Income divided by the property price (or asking sales price).
Capital Improvement – the addition of a permanent structural change or the restoration of some aspect of a property that will either enhance the property’s overall value, prolongs its useful life, or adapt it to new uses. Individuals, businesses, and cities can make capital improvements to the property they own. Often capital improvements are given favorable tax treatment and may be exempted from sales tax in certain jurisdictions.
Cash Flow – Cash flow is the net amount of cash and cash-equivalents being transferred into and out of a business. At the most fundamental level, a company’s ability to create value for shareholders is determined by its ability to generate positive cash flows, or more specifically, maximize long-term free cash flow (FCF). source
Class A Property – These properties represent the highest quality buildings in their market and area. They are generally newer properties built within the last 15 years with top amenities, high-income earning tenants and low vacancy rates. Class A buildings are well-located in the market and are typically professionally managed. Additionally, they typically demand the highest rent with little or no deferred maintenance issues.
Class B Property – These properties are one step down from Class A and are generally older, tend to have lower income tenants, and may or may not be professionally managed. Rental income is typically lower than Class A, and there may be some deferred maintenance issues. Mostly, these buildings are well-maintained, and many investors see these as “value-add” investment opportunities because the properties can be upgraded to Class B+ or Class A through renovations and improvements to common areas. Buyers are generally able to acquire these properties at a higher CAP Rate than a comparable Class A property because these properties are viewed as riskier than Class A.
Class C Property – These properties are typically more than 20 years old and located in less than desirable locations. The properties are generally in need of renovation, such as updating the building infrastructure to bring it up to date. As a result, Class C buildings tend to have the lowest rental rates in a market with other Class A or Class B properties. Some Class C properties need significant reposting to get to steady cash flows for investors.
Closing Costs are the expenses, over and above the property’s price, that buyers and sellers usually incur to complete a real estate transaction.
Code of Ethics – code of ethics is a guide of principles designed to help professionals conduct business honestly and with integrity. A code of ethics document may outline the mission and values of the business or organization, how professionals are supposed to approach problems, the ethical principles based on the organization’s core values, and the standards to which the professional is held.
Common Area Maintenance – is one of the three main components that make up operating expenses, the other two being insurance and property taxes. Common Area Maintenance (CAM) expenses are fees paid by tenants to landlords to help cover costs associated with overhead and operating expenses for common areas. Common areas are spaces used for or benefited by all tenants and include, but are not limited to, hallways, elevators, parking lots, lobbies, public bathrooms and building security.
Concessions – in negotiations to attract tenants, a landlord will sometimes grant concessions. These most often take the form of free rent but may also include lease buyouts, moving allowances and above-standard tenant improvement allowances. In a hot real estate market concessions are difficult to negotiate.
Contingent Offer – a contingent offer is an offer to purchase property subject to certain conditions, including the buyer’s approval of income and expense statements, title commitment, physical condition of the property, loan commitment, etc. – being met. The specific amount of time allowed to clear these provisions is called the inspection or contingency period.
Demising Wall – a demising wall is a wall that separates spaces belonging to different tenants in an apartment building. It is even used to define the wall that separates tenants in a multi-tenant commercial building, such as a retail plaza, shopping mall, or office buildings.
Debt-Service Coverage Ratio (DSCR) – Debt-Service Coverage Ratio applies to corporate, government, and personal finance. In the context of corporate finance, the debt-service coverage ratio (DSCR) is a measurement of a firm’s available cash flow to pay current debt obligations. The DSCR shows investors whether a company has enough income to pay its debts. In the context of government finance, the DSCR is the amount of export earnings needed by a country to meet annual interest and principal payments on its external debt. In the context of personal finance, it is a ratio used by bank loan officers to determine income property loans. source
Early Suppression Fast Response (ESFR) – systems are quick responding, high volume sprinkler systems that provide exception protection for high piled storage occupancies. Instead of merely controlling a fire until the original fuel source is depleted, ESFR systems are designed to suppress the fire by discharging a large volume of water directly to the fire to reduce the heat release rate. These systems, installed at the ceiling, use large volumes of water delivering large water droplets at a high velocity to knock down the fire plume and provide enhanced protection for High Piled Storage Occupancies.
Earnest Money – is a deposit made to a seller that represents a buyer’s good faith to buy a home. The money gives the buyer extra time to get financing and conduct the title search, property appraisal, and inspections before closing. In many ways, earnest money can be considered a deposit on a home, an escrow deposit, or good faith money. source
Escalation Clause – an escalation clause in a lease providing for an increase in rent at a future time. This could be a fixed or pre-determined rate increase, or a cost of living increase that ties the rent to a cost of living index, or direct expense – the rent is adjusted according to changes in the expenses of the property such as a tax increase.
Escrow – escrow is a legal concept describing a financial instrument whereby an asset or escrow money is held by a third party on behalf of two other parties that are in the process of completing a transaction. Escrow accounts might include escrow fees managed by agents who hold the funds or assets until receiving appropriate instructions or until the fulfillment of predetermined contractual obligations. Money, securities, funds, and other assets can all be held in escrow. A similar process would be a fully funded documentary letter of credit. It is often suggested as a replacement for a certified or cashiers check. source
Estoppel Certificate – an estoppel certificate is a document signed by a tenant that states what the current status is on their lease. In the tenant estoppel certificate, the tenant will confirm certain details of the lease, such as the amount of their rent payment and security deposit, to assist a third party in their due diligence. In most cases, the third party is either a buyer or a lender.
Expense Stop – Provision in a lease establishing the maximum level of operating expense(s) to be paid by the landlord and included in the base rent. Expenses beyond this level are to be reimbursed by the tenant. Most commonly applied to total operating expenses but may be applied to specific expenses only. Often expressed per square foot of rentable area.
Full-Service Lease – a full-service lease refers to a gross lease where the owner pays the operating expenses of a property. In some cases, a full service, or fully serviced, lease means that the landlord covers certain other expenses, such as cleaning services, which is quite common in office leases.
Forbearance – a forbearance is an agreement between a lender and a borrower to temporarily suspend debt payments. For mortgages, lenders may opt to foreclose on borrowers who are unable to make payments. To avoid a costly foreclosure, the lender and the borrower can negotiate a forbearance agreement to allow the borrower to catch up on payments. For student loans, forbearance postpones payments under certain hardship conditions; however, interest continues to accrue on the principal balance.
Gross Lease – a gross lease of property whereby the landlord (i.e., lessor) pays for all property charges usually included in ownership. These charges can include utilities, taxes, and maintenance, among others.
Gross Profit Margin – gross profit margin is a metric analyst use to assess a company’s financial health by calculating the amount of money left over from product sales after subtracting the cost of goods sold (COGS). Sometimes referred to as the gross margin ratio, gross profit margin is frequently expressed as a percentage of sales. source
Heating, Ventilation, and Air Conditioning System (HVAC) – The mechanical systems that provide thermal comfort and air quality in an indoor space are often grouped together because they are generally interconnected. HVAC systems includes central air conditioners, heat pumps, furnaces, boilers, rooftop units, chillers, and packaged systems.
Holdbacks – holdbacks are mechanisms used when a seller, at the time of closing the transaction, still has outstanding contractual obligations to fulfill before the sale proceeds can be released.
Hyperinflation – hyperinflation is a term to describe rapid, excessive, and out-of-control general price increases in an economy. While inflation is a measure of the pace of rising prices for goods and services, hyperinflation is rapidly rising inflation, typically measuring more than 50% per month.
Indemnity – is a contractual agreement between two parties. In this arrangement, one party agrees to pay for potential losses or damages caused by another party. A typical example is an insurance contract, in which the insurer or the indemnitor agrees to compensate the other (the insured or the indemnitee) for any damages or losses in return for premiums paid by the insured to the insurer. With indemnity, the insurer indemnifies the policyholder—that is, promises to make whole the individual or business for any covered loss.
Lease Commencement Date – usually constitutes the commencement of the term of the lease for all purposes, regardless if the tenant has actually taken possession of the space but so long as beneficial occupancy is possible. In other words, it is when the lease term and benefits of the lease officially commence.
Liability Insurance – The term liability insurance refers to an insurance product that provides an insured party with protection against claims resulting from injuries and damage to other people or property. Liability insurance policies cover any legal costs and payouts an insured party is responsible for if they are found legally liable. Intentional damage and contractual liabilities are generally not covered in liability insurance policies. Unlike other types of insurance, liability insurance policies pay third parties – not policyholders. source
Liquidity – Liquidity refers to the efficiency or ease with which an asset or security can be converted into ready cash without affecting its market price. The most liquid asset of all is cash itself.
Net Absorption – the net change in occupied space in a given market between the current measurement period and the last measurement period. Net absorption can be either positive or negative and must include decreases as well as increases in inventory levels. It is recommended to disclose the inclusion (Total Net Absorption) or exclusion (Direct Net Absorption) of sublease space in any calculation of net absorption.
Net Income – net income (NI), also called net earnings, is calculated as sales minus cost of goods sold, selling, general and administrative expenses, operating expenses, depreciation, interest, taxes, and other expenses. It is a useful number for investors to assess how much revenue exceeds the expenses of an organization. This number appears on a company’s income statement and is also an indicator of a company’s profitability.
Net Operating Income – net operating income also known as NOI. This is the annual net income remaining after deducting all fixed and operating variable expenses, but before debt service and income tax. The specific formula is: NOI = Scheduled rental income + other income – vacancy and credit losses – operating expenses.
Operating Income – operating income is an accounting figure that measures the amount of profit realized from a business’s operations, after deducting operating expenses such as wages, depreciation, and Cost of goods sold (COGS).
Overhead – overhead refers to the ongoing business expenses not directly attributed to creating a product or service. It is important for budgeting purposes but also for determining how much a company must charge for its products or services to make a profit. In short, overhead is any expense incurred to support the business while not being directly related to a specific product or service. source
Parking Ratio is a statistic used to determined how much parking is available for a commercial property. To determine parking ratio, simply take the amount of parking spaces divided by the square footage of the property (usually measured by 1,000s of sq. ft.).
Per Square Foot (PSF) – Commercial real estate property rental rates are often quoted on a per-square-foot, annual basis. In a rental situation, the rate will either be Net or Gross numbers (“Net PSF” or “Gross PSF”). If a rent is quoted on a net basis, this number does not include the tenant’s pro-rated responsibility of taxes or common area expenses (known as CAM).
Percentage Lease – a percentage lease is when the tenant pays a minimum rent then also pays a percentage of the volume of the business done on the premises whichever is greater. The percentage paid differs according to the types of business.
Profit and Loss – the profit and loss (P&L) statement is a financial statement that summarizes the revenues, costs, and expenses incurred during a specified period, usually a fiscal quarter or year. The P&L statement is synonymous with the income statement.
REIT – (Real Estate Investment Trust) – a security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate.
Rent Escalation – Rent Escalation is a lease provision in which the landlord requires the tenant to pay a higher aggregate rent by adjusting the annual base rent by an agreed method during the term of the lease agreement.
Rentable Square Footage (RSF) and Usable Square Footage (USF)
RSF includes any shared space. This figure is primarily used by landlords to determine the rental amount for a commercial property. USF is the amount of space available to be used in a property. It gives you an accurate estimation of how much working space you have in a building, aside from shared spaces such as stairways, bathrooms, and hallways.
Request for Proposal (RFP) is a business document that announces a project, describes it, and solicits bids from qualified contractors to complete it. Most organizations prefer to launch their projects using RFPs, and many governments always use them. When using an RFP, the entity requesting the bids is responsible for evaluating the feasibility of the bids submitted, the financial health of the bidding companies, and each bidder’s ability to undertake the project.
Return on Investment – (ROI) a performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. To calculate ROI, the benefit (return) of an investment is divided by the cost of the investment; the result is expressed as a percentage or a ratio. ROI = (Gain from Investment – Cost of Investment) / Cost if Investment
Right of First Refusal – (ROFR) gives a tenant the ability to accept or decline any additional and unused space that the landlord has available in a property. A ROFR clause in a lease means a landlord is contractually obliged to make this offer to the tenant, before offering spaces to the public.
Risk Management – the continuing process to identify, analyze, evaluate, and treat loss exposures and monitor risk control and financial resources to mitigate the adverse effects of loss.
Tenant Improvements or Tenant Improvement Allowance – (TI) the customized alterations a building owner makes to rental space as part of a lease agreement, in order to configure the space for the needs of that particular tenant. These include changes to walls, floors, ceilings, and lighting, among others. In actual practice, these customized tenant improvements usually have a useful economic life of 5 to 10 years, which spans the average commercial lease term.
Tenancy in Common (TIC) is an arrangement where two or more people share ownership rights in a property or parcel of land. Each independent owner may control an equal or different percentage of the total property, which can be commercial or residential. When a tenant in common dies, their share of the property passes to their estate; they have the right to leave it to any beneficiary they choose. source
Triple Net Lease – (NNN) A lease agreement that designates the lessee (the tenant) as being solely responsible for all of the costs relating to the asset being leased in addition to the rent fee applied under the lease. The structure of this type of lease requires the lessee to pay for net real estate taxes on the leased asset, net building insurance and net common area maintenance. The lessee has to pay the net amount of three types of costs, which how this term got its name.
Vacancy Rate – vacancy rate means the number of units available on rental basis which are vacant or unoccupied in an apartment, building, complex, hotels, or colony, at a given time period and the same being expressed in percentage terms. In other words, it is exactly the opposite of the occupancy rate. source
Working Capital – working capital, also known as net working capital (NWC), is the difference between a company’s current assets, such as cash, accounts receivable (customers’ unpaid bills), and inventories of raw materials and finished goods, and its current liabilities such as accounts payable. NWC is a measure of a company’s liquidity and refers to the difference between operating current assets and operating current liabilities. In many cases, these calculations are the same and are derived from company cash plus accounts receivable plus inventories, less accounts payable, and less accrued expenses. source
Zoning – zoning refers to municipal or local laws or regulations that dictate how real property can and cannot be used in certain geographic areas. Zoning laws can limit commercial or industrial use of land in order to prevent oil, manufacturing or other types of businesses from building in residential neighborhoods. These laws can be modified or suspended if construction of the property will serve to help the community advance economically.