If you are serious about becoming a real estate investor, you are going to have to learn to walk the walk and talk the talk. Like most industries, real estate has developed a specialized language – complete with acronyms, expressions, technical terms and idioms all its own. Even seasoned professionals must work to keep up with the latest investment vernacular. Here is a beginner’s glossary to introduce you to the world of real estate jargon.
An accredited investor is a term used by the U.S. Securities and Exchange Commission (SEC) under Rule 501 of Regulation D. The coveted designation is reserved for persons or entities that can deal with securities not registered with financial authorities by satisfying one of the requirements regarding income, net worth, asset size, governance status or professional experience. In Canada, the term is defined by the various provincial securities commissions and generally includes income and asset criteria in order to qualify.
Active income is income earned as a direct result of a specific effort. In other words, input is correlated to output. Wages, tips, salaries, bonuses and income derived from material participation in business activity is generally considered active income.
An alternative investment refers to any investment that does not qualify as “traditional”. Traditional investments are widely considered to be stocks, bonds and cash.
Amortization refers to the gradual paying down or reduction of debt over time owing to periodic payments of principal and interest.
Appreciation in investment circles refers to an increase in value in an asset. It is the opposite of depreciation.
A basis point (bp) is a unit equal to 1/100th of 1% or .01%. Basis points are frequently used when talking about interest rates. An interest rate increase of 100 basis points equals a 1% increase.
Capital is used to refer to any financial asset.
A capital gain is any increase in the value of an asset that exceeds the purchase price for the asset. The most common capital gains are derived from the sale of stocks, bonds and real estate. In both Canada and the U.S., capital gains are taxed differently from ordinary income.
Capital Gain Taxes
Capital gain taxes are taxes applied to realized capital gains upon the sale of an asset, such as stocks, bonds or real estate.
Capitalization (Cap) Rate
Capitalization or Cap Rate measures the profitability of a real estate investment and is calculated by dividing the property’s net operating income by its current market value, without taking debt service into consideration. Cap Rates are critical to anyone analyzing investments because they allow comparison of one property against another.
In commercial real estate, capital stack refers to the different layers of financing that go into purchasing and improving real estate. The capital stack orders the seniority of claims in relation to the collateral and cash waterfall of an entity.
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 pre-tax cash flow by the total cash invested in a project.
Common equity means that investors have one-to-one (or equal) participation in each dollar invested and any potential profits or losses.
The cost basis of an investment is an investor’s initial stake which is typically the initial price they pay to acquire that investment.
Crowdfunding is the use of small amounts of capital from a large number of individuals to finance a new business venture.
Debt is a sum of money (the obligation) owed by one party (the debtor) to another party (the creditor).
Development is the process of building or adding to existing structures to increase the value of a property.
Distributions are periodic payments derived from earnings and made to shareholders, members, partners or other participants in an investment.
Equity is the difference between the value of an asset and the value of the liabilities against that asset. As it relates to real estate, equity can be measured as the amount of capital invested in a property.
Free Cash Flow
Free cash flow is a measure of a property’s ability to generate cash after setting aside reserves for capital expenditures such as future development, tenant improvements, and leasing commissions.
A hard asset is a tangible object of worth that is owned by a business or individual, such as a building, cash, gold or minerals.
Internal Rate of Return (IRR)
In real estate, the Internal Rate of Return (IRR) is a metric used to evaluate the profitability of an investment over its lifetime and is represented as the average annual return percentage. The IRR of an investment can be calculated going forward to estimate potential future returns or backward in order to measure the performance of a completed investment.
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
The JOBS Act was a law passed in 2012 in the U.S. that eased regulations related to funding small businesses. Intended to increase American job creation and foster economic growth, the JOBS Act aims to provide easier access to public capital markets and small, growing companies.
Linear income is income earned in direct relation to the number of hours worked.
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.
The liquidity premium represents the incrementally higher price an investor is willing to pay for a more liquid asset or security, all other factors being equal.
Loan-to-Cost Ratio (LTC)
The Loan-to-Cost Ratio (LTC) is the ratio of a loan used to finance a project compared to the total cost of the project.
Loan-to-Value Ratio (LTV)
The Loan-to-Value Ratio is the ratio of a loan compared to the appraised value of an asset. LTV is a critical measure of risk assessment for lenders considering a real estate loan.
Mezzanine (or “Middle”) Debt generally refers to a form of debt and equity financing in which the senior mortgage debt is secured by a mortgage interest in the physical property and junior or mezzanine debt is secured by an interest in the entity that owns the property.
Net Asset Value (NAV)
Net Asset Value represents the value of an entity’s assets minus the value of its liabilities.
Net Operating Income (NOI)
Net Operating Income is the revenue (or income) generated by an investment property after deducting operating expenses.
In the U.S., Opportunity Zones are census tracts generally composed of economically distressed communities that qualify for a community development program called the Opportunity Zone program, which was created under the Tax Cuts and Jobs Act of 2017.
Passive income (also known as residual or recurring income) is commonly used to refer to income that continues to be earned even after the work is done. interest, dividends and capital gains are common sources of passive income.
Preferred equity refers to a partnership where the preferred partner’s interests have a higher priority when it comes to the distribution of cash flow and 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 describes the claim on profits given to preferred investors in a project. A preferred return is paid to investors before a sponsor receives any share of the cash flow
Private Equity (PE)
A Private Equity 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.
A pro forma is a financial model often used in real estate to predict future cash flow and total investment returns.
Real estate or real property includes a parcel of land and any of the permanent structures (buildings, parking lots, etc.) appurtenant to the land
Real Estate Investment Trust (REIT)
A REIT is a company that makes investments in and owns income-generating real estate.
Also known as residual or passive income, recurring income is earned by creating or acquiring an asset that continues to generate income on a regular basis even when there is no work being done.
In real estate, the right of redemption is the right of a debtor whose property has been foreclosed upon to reclaim that property by paying the debt.
Secured vs Unsecured Position
A lender holding 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 is generally secured at the base of the capital stack. It takes priority over junior and unsecured debt and must be repaid first.
A sponsor is an individual or firm in charge of finding, acquiring, and managing real property to present to investors.
Step-Up in Basis
Step-up in basis is an adjustment to the cost basis of an asset. Certain factors may initiate a step-up in basis to an investor’s original cost basis, thereby reducing the realized capital gain and associated tax liability.
Tenancy is a term used to define the percentage of the total square footage in a building or project that is leased to tenants.
In real estate, term refers to the lifespan of a given asset or liability. At the end of the term, a lease expires, or a loan is repaid, etc.
Title III Regulation Crowdfunding
Outlined in the 2012 JOBS Act, Title III instructed the SEC to create an exemption from registration that, when implemented, enables issuers to engage in crowdfunding equity offerings to the general investing public.
An unaccredited investor is one who does not meet the wealth requirements of an accredited investor set forth by the SEC, in the U.S., or as determined by provincial regulations in Canada.
Underwriting is the process by which real estate investments are evaluated to determine viability.
In the context of commercial real estate, yield refers to the annual cash return on an investment, expressed as a percentage of the investment’s initial cost, or less frequently, its estimated current value.
One thought on “An Introduction to Real Estate Investment Jargon”
The JOBS Act actually paved the way for real estate crowdfunding. Good to know.