Get Familiarized with Common Commercial Real Estate Terminologies
August 22, 2017
Adjusted Basis - The original cost basis of a property plus capital improvements, less total accumulated cost recovery deductions, and partial sales taken during the holding period.
Amortization - The repayment of loan principal through equal payments over a designated period of time consisting of both principal and interest.
Assessed Value - The value of real property established by the tax assessor for the purpose of levying real estate taxes.
Cap Rate - A percentage that relates the value of an income-producing property to its future income, expressed as net operating income divided by purchase price. Also referred to as cap rate.
Cash-on-Cash Rate - A return measure that is calculated as cash flow before taxes divided by the initial equity investment.
Cost Recovery - An annual deduction based on the class life of an asset.
Depreciation - The loss of utility and value of a property.
Due Diligence - The process of examining a property, related documents, and procedures conducted by or for the potential lender or purchaser to reduce risk. Applying a consistent standard of inspection and investigation one can determine if the actual conditions do or do not reflect the information as represented.
Exchange - Under Section 1031 of the Internal Revenue Code, like-kind property used in a trade or business or held as an investment can be exchanged tax-deferred. Under a fully qualified Section 1031 exchange, real estate is traded for other like-kind property. All capital gains taxes are deferred until the newly acquired real estate is disposed of in a taxable transaction. The underlying philosophy behind the deferral of capital gains taxes is that taxation should not occur as long as the original investment remains intact in the form of (like-kind) real estate (like-kind refers to real property as such, rather than the quality or quantity of property).
Expense stop - The level (or maximum amount) up to which the landlord will pay certain operating expenses. Amounts above the stop are the responsibility of the tenant.
Fixed Expenses - Costs that do not change with a building’s occupancy rate. They include property taxes, insurance, and some forms of building maintenance.
Fully Amortized Mortgage Loan - A method of loan amortization in which equal periodic payments completely repay the loan.
Gross Area - The entire floor area of a building or the total square footage of a floor.
Gross Leasable Area (GLA) - The total floor area designed for tenant occupancy and exclusive use, including basements, mezzanines, and upper floors, and it is measured from the center line of joint partitions and from outside wall faces. GLA is that area on which tenants pay rent; it is the area that produces income.
Gross Lease - A lease in which all expenses associated with owning and operating the property are paid by the landlord. Also see net lease.
Gross Operating Income - The total income generated by the operations of a property before payment of operating expenses. It is calculated from potential rental income, plus other income affected by vacancy, less vacancy and credit losses, plus other income not affected by vacancy.
Gross Rent Multiplier (GRM) - A method investors may use to determine market value. This method calculates the market value of a property by using the gross rents an investor anticipates the property will produce at end of year 1 multiplied by a given factor (known as the gross rent multiplier extracted from the marketplace).
Ground Lease - A lease of the land only. Usually the land is leased for a relatively long period of time to a tenant that constructs a building on the property. A land lease separates ownership of the land from ownership of buildings and improvements constructed on the land.
Highest and Best Use - The reasonably probable and legal use of vacant land or an improved property, which is physically possible, appropriately supported, financially feasible, and that results in the highest value.
Internal Rate of Return (IRR) - The percentage rate earned on each dollar that remains in an investment each year. The IRR of an investment is the discount rate at which the sum of the present value of future cash flows equals the initial capital investment.
Lessee - The person renting or leasing the property. Also known as a tenant.
Lessor - The person who rents or leases a property to another. Also known as a landlord.
Leverage - The use of borrowed funds to finance a portion of the cost of an investment.
Loan-to-Value Tatio (L/V) - The amount of money borrowed in relation to the total market value of a property. Expressed as the loan amount divided by the property value.
Market Value - The most probable price that a property would bring in a competitive and open market under fair sale conditions. Market value also refers to an estimate of this price.
Net Operating Income (NOI) - The potential rental income plus other income, less vacancy, credit losses, and operating expenses.
Net Present Value (NPV) - The sum of all future cash flows discounted to present value and netted against the initial investment.
Operating Expenses - Cash outlays necessary to operate and maintain a property. Examples of operating expenses include real estate taxes, property insurance, property management and maintenance expenses, utilities, and legal or accounting expenses. Operating expenses do not include capital expenditures, debt service, or cost recovery.
Original Basis - The total amount paid for a property, including equity capital and the amount of debt incurred.
Principal - The portion of a loan payment used toward reducing the original loan amount.
Rate of Return - The percentage return on each dollar invested. Also known as yield.
Replacement Cost - The estimated cost to construct, at current prices, a building with utility equivalent to the building being appraised, using modern materials and current standards, design, and layout.
Tenant Improvements - Preparation of leased premises prior to or during a tenant’s occupancy, which may be paid for by either the landlord, the tenant, or both.
Time Value of Money (TVM) - An economic principle recognizing that a dollar today has greater value than a dollar in the future because of its earning power.
Yield - A measure of investment performance that gauges the percentage return on each dollar invested. Also known as rate of return.
If you have any questions regarding any of the terms above or is interested in investing in commercial real estate investments, please don’t hesitate to contact one of our Advisors.
Previously, we talked about the Top 5 Reasons to Invest in Real Estate. Hopefully that peaked your interest. However before you blindly walk into a commercial real estate investment, it would be wise to familiarize yourself with some common real estate terminologies. Below are some words you will hear often when dealing with a commercial real estate investments.
Absorption - The amount of inventory or units of a specific commercial property type that become occupied during a specified time period (usually a year) in a given market, typically reported as the absorption rate.
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