Key Terms for Investors
An accredited investor is a person who meets certain financial criteria, such as having a high income or a substantial net worth, is known as an accredited investor. This status allows them to invest in securities, including becoming a limited partner in an apartment syndication. To qualify as an accredited investor, an individual must have an annual income of at least $200,000, or a joint income of $300,000 for the past two years, with an expectation of earning the same or more in the future. Alternatively, they must have a net worth of at least $1 million, either individually or jointly with a spouse.
Financial assets that fall outside the traditional categories of stocks, bonds, and cash are referred to as alternative investments. Examples of alternative investments include private equity or venture capital, hedge funds, managed futures, art and antiques, commodities, and derivatives contracts. Real estate is another asset class that is often considered an alternative investment.
Unlike an interest-only loan, where each payment only covers the interest and the principal is repaid as a lump sum at the end of the loan term, an amortizing loan requires each payment to include both interest and principal repayments.
When the value of an asset rises, it is commonly known as “appreciation”.
In multifamily real estate investing asset management refers to the process of managing a rental property or portfolio of properties in order to maximize the value and performance of the assets.
A basis point (bps) is a measurement unit that represents 1/100th of 1%, which is equivalent to 0.01%, likewise, a 1% change is equal to a 100 basis point change.
Capital refers to any type of financial asset or the monetary value of an asset.
The capital stack refers to the various sources of capital that are used to finance a real estate investment, including equity and debt. In a multifamily investment, the capital stack typically includes a combination of personal equity from the investor, a mortgage loan from a lender, and possibly additional financing from other sources such as mezzanine debt or preferred equity.
The capitalization rate, or cap rate, is a measure of the expected return on investment for a rental property. It is calculated by dividing the net operating income (NOI) of the property by the current market value of the property. The cap rate is expressed as a percentage and reflects the rate of return that an investor can expect to receive based on the current market conditions.
The cap rate is a useful measure for evaluating the potential profitability of a rental property because it takes into account the current market value of the property and the expected income from the property. It is a commonly used metric in real estate investing because it allows investors to compare the expected return on different properties on an equal basis.
Cash-on-cash return is a measure of the cash income that an investor receives on a rental property compared to the amount of cash invested. It is calculated by dividing the annual cash income by the initial cash investment and expressing it as a percentage.
For example, if an investor buys a multifamily property for $500,000 with a down payment of $100,000 and receives annual rental income of $10,000, the cash-on-cash return would be calculated as follows:
Cash-on-cash return = ($10,000 / $100,000) x 100% = 10%
In this example, the investor would receive a cash-on-cash return of 10% on their initial investment of $100,000.
Common equity refers to a type of investment where each investor has an equal share in the potential profits or losses, with one-to-one participation for each dollar invested.
In real estate investing, core, core plus, value-add, and opportunistic opportunities refer to different types of investment strategies that are based on the level of risk and the amount of work required to realize the potential value of a property.
Core investments are typically considered the least risky and most stable type of real estate investments. They are typically high-quality properties in established locations that are fully leased and generate stable cash flow. Core investments are typically targeted to investors who are looking for a low-risk, long-term hold with a focus on income and stability.
Core plus investments are similar to core investments in that they are typically well-located, high-quality properties, but they may have some additional value-creation potential. This could include properties that are partially leased or require some minor renovations or upgrades. Core plus investments are typically targeted to investors who are looking for a moderate level of risk and a longer-term hold with a focus on income and value appreciation.
Value-add investments are properties that have significant potential for value creation through renovations, repositioning, or other improvements. These properties may be under-performing, partially leased, or in need of significant renovations. Value-add investments are typically targeted to investors who are looking for a higher level of risk and a shorter-term hold with a focus on value appreciation.
Opportunistic investments are typically the highest risk and highest potential reward type of real estate investments. They may include properties that are in disrepair, under-performing, or in need of significant renovations or redevelopment. Opportunistic investments are typically targeted to investors who are looking for a high level of risk and a shorter-term hold with a focus on value appreciation.
It is important to note that these categories are broad generalizations, and the specific risk and reward profile of a particular investment will depend on a variety of factors, including the local real estate market, the condition of the property, and the investor’s goals and risk tolerance.
Crowdfunding is the process of financing a product, idea, or venture by raising small amounts of money from a large number of people, typically through an online platform.
A debt is a sum of money that is owed by one party, known as the debtor, to another party, known as the creditor.
The debt service coverage ratio (DSCR) is a metric used to assess whether a rental property generates enough income to cover its debt obligations. The calculation involves dividing the property’s net operating income (NOI) by the total debt service, which includes mortgage payments and other financing costs.
The DSCR is a critical factor to consider when investing in multifamily real estate, as it determines the property’s ability to generate enough income to meet its debt obligations. A higher DSCR is typically viewed as a safer investment, as it provides a greater margin of safety and reduces the risk of mortgage default.
Typically expressed as a ratio, a DSCR of 1.0 or greater indicates that the property is generating enough income to cover its debt service, while a ratio below 1.0 suggests that the property may not generate enough income to cover its debt service and could be at risk of default.
Development involves the construction or expansion of structures with the aim of enhancing the value of a property.
Investors receive periodic payments, usually on a monthly basis, from profits or interest payments. These payments are known as distributions.
Regarding real estate, equity can be quantified as the capital that a sponsor, or property owner/developer, invests in a property.
Free cash flow in real estate is a metric that indicates the property’s capacity to generate cash after allocating funds for capital expenditures, including tenant improvements, leasing commissions, and future developments.
A hard asset is a valuable tangible item owned by an individual or a business
Internal rate of return (IRR) is a measure of the profitability of an investment, expressed as a percentage. It represents the discount rate that makes the net present value (NPV) of an investment equal to zero. In other words, it is the rate at which the sum of the cash flows from an investment, discounted back to present value, equals the initial investment.
IRR is a widely used measure of investment performance because it takes into account the time value of money, meaning that it recognizes that a dollar received in the future is worth less than a dollar received today. IRR allows investors to compare the profitability of different investments on an equal basis, regardless of their size or timing of the cash flows.
IRR is calculated by iteratively solving for the discount rate that results in a NPV of zero. This process can be done manually using a financial calculator or spreadsheet software, or it can be done automatically using specialized software.
IRR is often used in real estate investing to evaluate the potential return on investment for a rental property. It is important to note that IRR does not account for the risk of an investment, so it is generally used in conjunction with other measures, such as the capitalization rate or the cash-on-cash return, to assess the overall performance of an 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.
An investment property is a real estate asset acquired for the sole purpose of generating income. Such income can be obtained either by leasing the property or selling it at a later date.
The JOBS Act was passed in 2012 in the United States to promote economic growth and job creation by reducing regulations on funding for small businesses. One of the key objectives of the JOBS Act is to make it easier for small and growing companies to access public capital markets by easing regulatory requirements. By doing so, the Act aims to encourage more companies to go public and raise capital to fund their growth and expansion.
The term “liquidity” describes how easily an asset can be bought or sold. Assets that are frequently traded in high volume, such as marketable securities, are generally considered to be more liquid because they can be bought or sold without significantly impacting their market price.
The loan-to-cost (LTC) ratio is a metric used in commercial real estate construction to compare the financing of a project (as offered by a loan) with the cost of building the project. The LTC ratio allows commercial real estate lenders to determine the risk of offering a construction loan.
The loan-to-value (LTV) ratio is a financial metric that compares the mortgage amount to the property’s appraised value. A larger down payment will result in a lower LTV ratio. Mortgage lenders typically use the LTV ratio to determine if they will grant a loan and whether they will require private mortgage insurance.
Mezzanine debt and preferred equity are two types of financing structures used in real estate investments. Mezzanine debt is a loan that is secured by a property and is considered to be 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 and is not secured by the property itself. Instead, it is secured by an interest in the entity that is investing in or owning the property. These two financing structures are often used in combination to create a capital stack that meets the needs of both the borrower and the lender.
Net operating income (NOI) is a measure of the profitability of a rental property, calculated as the total rental income minus the operating expenses for the property. Operating expenses include all of the expenses that are necessary to maintain and operate the property, such as property taxes, insurance, utilities, and repairs and maintenance.
NOI is a useful measure of the property’s performance because it reflects the income that is available to pay for debt service, such as mortgage payments or other financing costs, as well as to provide a return on investment to the owner.
NOI is calculated as follows:
NOI = Gross rental income – Operating expenses
For example, if a multifamily property has gross rental income of $100,000 per year and operating expenses of $50,000 per year, the NOI would be calculated as follows:
NOI = $100,000 – $50,000 = $50,000
In this example, the NOI for the property is $50,000 per year.
It is important to note that NOI does not include any financing costs, such as mortgage payments or interest, or any capital expenditures, such as major renovations or repairs. As a result, NOI may not provide a complete picture of the overall profitability of a rental property. It is often used in conjunction with other measures, such as the capitalization rate or the cash on cash return, to assess the overall performance of an investment.
A building’s occupancy refers to the percentage of total square footage or units that are leased out, and is a key source of revenue.
Passive income (also known as residual or recurring income) is a term often used to describe income that continues to be generated even after the initial work has been completed. This type of income requires minimal effort to maintain and can be earned through various sources, such as rental income from real estate investments, royalties from creative works, or dividends from stock investments. The appeal of passive income lies in its ability to provide a steady stream of income with little ongoing effort or time commitment.
In a Preferred Equity investment, cash flow or profits are usually distributed to the preferred investors, after all debt obligations have been met. This distribution continues until the preferred investors receive the agreed upon “preferred return.” The preferred return is the rate of return that the preferred investors will receive before any other equity investors receive a distribution of profits.
Investors receive a Preferred Return before the sponsor is entitled to any share of the cash flow generated from the ongoing business or the sale of assets.
A private equity (PE) fund is a type of investment vehicle that pools money from multiple investors and uses the funds to invest in a variety of illiquid equity and debt assets. The fund is managed by a private equity firm, which makes investment decisions on behalf of the investors. Typically, private equity funds are structured as limited partnerships, with the private equity firm serving as the general partner and the investors serving as limited partners.
A proforma is a financial projection used to estimate the future performance of a rental property by making assumptions about its income, expenses, and financing. Typically utilized in multifamily real estate investing, proformas aid investors in evaluating a property’s potential profitability and making informed investment decisions.
These projections usually include estimates of the property’s gross income, net operating income (NOI), and cash flow, along with any financing costs and resulting return on investment.
While proformas are valuable in assessing multifamily properties, it is essential to note that they are based on approximations and assumptions, and actual performance may vary. Therefore, investors should use proformas as a starting point, conduct their own due diligence, and consider other factors such as the property’s location, condition, and market demand before investing.
Real estate comprises of a tract of land along with its fixed structures such as buildings, parking areas, and other permanent structures.
A Real Estate Investment Trust (REIT) is an investment vehicle that pools funds from multiple investors to invest in income-generating properties, such as commercial or residential real estate.
Recurring income, also referred to as passive or residual income, is the profit that is earned through an asset that generates consistent cash flows without the need for active work. The recurring income is typically earned on a regular basis and can provide a steady stream of income over an extended period of time, making it an attractive option for those seeking financial stability and independence.
Redemption refers to the act of reclaiming or regaining ownership or possession of something, typically by paying off a debt or fulfilling an obligation. In the context of real estate, redemption may refer to the process by which a borrower pays off back taxes or unpaid liens in order to reclaim ownership of their property and prevent foreclosure or auctioning.
A rent roll is a document that lists all of the units in a multifamily property, along with the current rent being charged for each unit and the tenant’s name. The rent roll is used to track the income being generated by the property and to identify any vacancies or units that may be under-rented.
The rent roll typically includes the unit number, the size of the unit (in square footage or number of bedrooms), the current rent, the tenant’s name, and the lease expiration date. It may also include information about the tenant’s payment history and any rent concessions that have been made.
The rent roll is an important tool for property managers and investors because it provides a snapshot of the property’s financial performance and helps identify opportunities for increasing income or reducing expenses. It is typically updated on a monthly or quarterly basis to reflect any changes in rent or occupancy.
Residual income, also known as passive or recurring income, refers to the income that an individual continues to earn after completing a specific task or activity. This type of income is typically generated from an asset, such as a rental property or investment portfolio, that continues to produce income even without ongoing active involvement from the individual. Residual income is often considered a desirable form of income as it can provide a steady stream of earnings with minimal ongoing effort or involvement.
In real estate financing, the capital stack refers to the different types of financing that are used to fund a property. This can include both debt and equity investments. The capital stack is arranged in a specific order of priority, with senior positions having priority over junior positions. The more senior a position is in the capital stack, the more secure the investment is considered to be.
A secured position in the capital stack refers to a position that is backed by collateral, such as a lien on the property. This means that in the event of a default or non-performance, the secured creditor has the right to foreclose on the property and sell it in order to recover their investment. This provides a high level of security for the creditor, as they have a tangible asset backing their investment claim.
On the other hand, unsecured creditors do not have any collateral backing their investment claim. This means that they do not have the right to foreclose on the property in the event of a default. Instead, they may have to rely on other legal means to recover their investment, such as seeking a judgment against the borrower. Unsecured creditors typically have a higher risk profile, as they have less security for their investment.
Senior debt, as the “base” of the Capital Stack, is typically a type of secured debt that holds the highest priority of repayment among all the types of financing or investments in a project or property.
A real estate sponsor is an individual or a company responsible for identifying, acquiring, and managing a real estate project or investment opportunity. They typically have expertise in real estate development, finance, and management, and are responsible for overseeing the entire investment process from the initial property acquisition to the final disposition or sale of the property. Real estate sponsors may also be involved in raising capital for the project, negotiating with lenders and investors, and making key decisions related to the property’s operation, maintenance, and improvement. The success of a real estate investment often depends on the skill and experience of the sponsor.
The period of time that an asset or liability remains active or effective.
Underwriting is a critical process in the real estate investment industry that involves the evaluation of various factors to determine the potential profitability and risk associated with a particular investment opportunity. The process involves analyzing key aspects such as the financials of the investment property, its location, condition, market demand, and other relevant factors that may impact its potential for success.
Real estate underwriting typically involves a thorough analysis of the property’s financial performance, including projected income and expenses, cash flow, and return on investment. Additionally, underwriters may also evaluate factors such as the local real estate market, economic conditions, and other external factors that may impact the investment’s potential for success.
The underwriting process is typically conducted by real estate professionals, including analysts, asset managers, and investment managers, who work closely with investors to evaluate investment opportunities and make informed investment decisions. The goal of underwriting is to identify potential risks and opportunities associated with a particular investment and to develop strategies to mitigate those risks and maximize the investment’s potential returns.
Commercial real estate yield refers to the annual cash flow generated by an investment expressed as a percentage of the initial investment cost or current estimated value. The yield is a measure of the return on investment, taking into account both the income generated by the property and any potential capital appreciation. It is a key metric used by investors to evaluate the profitability of a real estate investment and to compare different investment opportunities. A higher yield generally indicates a more attractive investment, although investors should also consider other factors such as market conditions, location, and property condition.