Real Estate Finance Vocabulary

Comprehensive practice flashcards defining core real estate finance, legal, debt, leasing, valuation, and risk analysis terms.

Financial Leverage

Using borrowed money to buy a property so the investor uses less equity; it can raise the leveraged return on equity and gives the tax deduction for mortgage interest; but risk rises as LTV rises.

Positive Leverage

The return on equity is higher with debt than without debt; the higher the LTV the higher the leveraged return on equity.

Negative Leverage

The return on equity is lower with debt than without debt; the higher the LTV the lower the leveraged return on equity.

Loan Underwriting

The lender's process of evaluating a loan; LTV and DSCR are two key elements; lenders are more secure with a lower LTV and a higher DSCR.

Tight Money

A period when mortgage money is scarce and expensive; lenders underwrite loans with lower LTVs and higher DSCRs.

Prepayment Penalties (Ch 12)

Loan terms that make it costly for a borrower to pay off or refinance a loan before the maturity date.

Yield Maintenance

A prepayment charge that compensates the lender for the interest it loses when a loan is repaid early.

Loan Lockout

A period during which the borrower is not allowed to prepay the loan at all.

Interest-Only Loan (Bullet Loan)

The borrower pays only interest with no principal amortization and the full balance (a balloon payment) is due at maturity.

Negative Amortizing Loan

The payment is less than the accrued interest so the loan balance increases; might be used when interest rates are very high.

Participating Loan

The lender receives extra interest based on a formula tied to gross income or NOI or cash flow; the lender has no ownership interest in the property.

Equity Kicker

The extra interest (participation) a lender receives in a participating loan.

Convertible Mortgage

The lender has the right to convert part or all of the loan principal into an ownership interest in the property at a specified time.

Mezzanine Loan

A loan often secured by the owner's equity in a property rather than by a mortgage on the property itself; usually requires an inter-creditor agreement with the first mortgage lender.

Inter-Creditor Agreement

An agreement between the mezzanine lender and the first mortgage lender about their rights relative to each other.

Preferred Equity

An ownership investment (not a mortgage) with a preferred return that is paid before other equity investors.

Sale-Leaseback

The seller sells the property for cash but keeps using it under a lease; a repurchase option may let the seller buy it back later.

Repurchase Option

The seller's right in a sale-leaseback to buy the property back in the future.

Net Operating Income (NOI)

Rent and other property income minus operating expenses (not debt service and not depreciation); often capitalized to find market value.

Taxable Income

Net operating income minus interest and tax depreciation.

After Tax Cash Flow

Before tax cash flow minus taxes.

Leverage

The use of debt to acquire or own a property.

Unleveraged vs. Leveraged Returns

The IRR and ROE and equity multiple without and with mortgage financing; leveraged returns should generally be higher to pay for the added risk.

Return on Equity (ROE)

The annual return relative to the investor's equity.

Capital Expenditures (Cap Ex)

Spending on major improvements or replacements that extend a property's life or value.

Depreciable Cost Basis

The part of the purchase price allocated to the improvements and not the land.

Investment Benefits

Cash flow after taxes and price appreciation and diversification.

Real Estate Cycle

The industry is cyclical with periods of growth and periods of decline in rents and occupancy and property values.

Investment Strategies

Risk/return focus (core or value-added or opportunistic) and property type and geographic focus.

Core

Lower-risk and stable and well-leased properties.

Value-Added

Moderate-risk investments with a chance to improve the property or its leasing.

Opportunistic

The highest-risk strategy with the highest potential return.

Market Analysis

Supply and demand analysis for a property type and local market plus absorption projections to forecast occupancy and rents.

Absorption

The rate at which available space gets leased.

Adjustable Rate Mortgage (ARM)

A loan whose interest rate is tied to a market index plus a margin and changes periodically.

Index

The market interest rate an ARM follows (such as SOFR or Treasuries or COFI or Prime); it can be overnight or $6$ months or $1$ year.

SOFR

Secured Overnight Financing Rate; replaced LIBOR in the U.S. as a benchmark index.

LIBOR

London Interbank Offered Rate; the older benchmark index that SOFR replaced.

COFI

The 11th District Cost of Funds Index; an index used for ARMs.

Margin

The lender's profit margin (spread) over the index; fixed for the loan term.

Reset Dates

The dates when the ARM interest rate changes (usually every $6$ months or $1$ year).

Caps and Floors

Caps are the maximum and floors are the minimum allowed periodic and/or lifetime adjustments of the interest rate or payment.

Periodic Cap

The most the rate can change at one reset.

Lifetime Cap

The most the rate can change (or the highest rate allowed) over the whole life of the loan.

Payment Cap

A limit on how much the payment can rise; it can cause negative amortization.

Interest Rate Cap

A limit on how much the interest rate can rise; it does not cause negative amortization.

Interest Rate Risk (ARM)

Higher for the borrower and lower for the lender on an ARM; the shorter the time between resets the higher the risk for the borrower.

Default Risk (ARM)

Possible rate increases raise the chance that the borrower defaults leading to foreclosure.

Conversion Option

The borrower's right to convert an ARM to a fixed rate loan at a specified future date usually for a fee.

Amortization

The process of repaying the principal balance of a loan over time.

Pay Rate vs. Accrual Rate

Asks whether the payment actually made covers at least the interest accrued; if not the unpaid interest is added to the loan balance.

Fully Amortizing

Payments pay the loan balance down to zero by maturity.

Partially Amortizing

Payments reduce the balance but a balloon payment remains at maturity.

Loan Fees and Costs

Origination fees and appraisal and credit report charges; fees and points increase the lender's yield.

Origination Fee

A fee for underwriting and processing the loan.

Prepayment Penalties

Fees for repaying a loan early; they raise the lender's effective yield and are negotiable and are NOT included in the APR; the earlier the loan is repaid the higher the lender's effective yield.

Capital Markets

Financial and securities markets including the mortgage market.

Loan Availability

Economic growth prospects and expected inflation and other risks affect the supply and cost of mortgage funds.

Lenders as Intermediaries

Most lenders originate loans and sell them into the secondary mortgage market rather than holding them to maturity.

Secondary Mortgage Market

The market where existing mortgage loans are bought and sold.

Loan Pricing

The interest rate and fees and points and costs charged by the lender and the loan terms (including prepayment penalties).

Risk-Adjusted Return

Expected investment return relative to the perceived risk.

Rental Income Types

Flat base rent and step-up rent and CPI or indexed rent (with caps or floors) and percentage rent.

Base Rent

The fixed rent amount before adjustments or add-ons.

Flat Base Rent

The same rent for the whole lease term.

Step-Up Rent

Rent that increases by scheduled amounts over time.

CPI or Indexed Rent

Rent that adjusts with an index like the Consumer Price Index and may have caps and floors.

Percentage Rent

Extra rent based on a percentage of the tenant's sales; overage rent is paid above a sales breakpoint.

Overage Rent

Percentage rent paid on sales above the breakpoint.

Concessions

Landlord incentives such as free rent or reduced rent or a tenant improvement allowance.

Tenant Improvement Allowance (TI)

Money the landlord contributes toward building out the tenant's space.

Gross Lease

The tenant pays no operating expenses (the landlord pays them).

Modified Gross Lease

The tenant pays some expenses (for example electricity).

Rentable vs. Usable Square Feet

Rentable square feet equal usable square feet plus the tenant's pro rata share of common areas (hallways and restrooms and lobbies and stairwells).

Parking

Spaces can be assigned to a tenant or allotted per thousand square feet of rented space; parking charges can be added to the rent or included in it.

Commercial Properties

Income-producing property types such as office and retail and apartment and industrial and hotel and mixed-use.

Supply and Demand Analysis

Used to value property and project future rent and occupancy; global and national and regional and local factors affect values and rents.

Location

The most important factor in real estate because real estate is location specific.

Lease Terms

The key provisions of a commercial lease (such as parties and premises and term and base rent and expenses and assignment and defaults).

Anchor Tenant

A major tenant that draws other tenants and provides stability.

Exclusivity Clause

The landlord agrees not to lease to the tenant's competitors.

Termination or Kick-Out Rights

A tenant's right to end the lease if certain conditions occur (such as low sales).

CAM Charges

Common Area Maintenance charges; the tenant's share of the upkeep of shared areas.

Overloading

Using more than the building's floors or systems are designed to handle; leases typically limit it.

Cap Rates and Interest Rates

Rising interest rates raise cap rates and lower prices; falling interest rates lower cap rates and raise prices; more demand relative to supply lowers cap rates.

Appraised Value

An opinion of value for a particular purpose and date by a particular appraiser; the three primary methods are sales comparison and capitalization of income and replacement cost.

Sales Comparison Approach

Compares recent sales of highly comparable properties (similar location and size and age and quality); generally the only method used for residential properties.

Capitalization of Income

Valuation based on income using the gross rent multiplier and capitalization of NOI and discounted present value (DCF).

Discounted Present Value (DCF)

Values a property using a typical $10$-year cash flow model discounted at the buyer's required IRR.

Discount Rate

The rate used to bring future cash flows back to present value (the buyer's required IRR in a DCF).

Physical Depreciation

Loss in a building's value from wear and tear and aging.

Market Value of a Loan

The present value of all expected future loan payments (principal and interest).

Below Market Seller Financing

Seller financing priced below the market (rate or fees or points or costs) often to get a better sale price from a motivated seller.

Annuity (PMT)

A series of equal payments at regular intervals (such as loan payments or rent).

Effective Yield

A measure of the return on capital or the cost of capital (like the interest rate and IRR).

n, i, PV, PMT, FV

The five variables in every time value of money problem; know four and solve for the fifth ($n$ = number of periods; $i$ = rate per period; $PV$ = present value; $PMT$ = payment; $FV$ = future value).

Purchase Money Loan

A loan made to a borrower to buy real estate.

Construction Loan

A loan to build a building or improvements; paid in draws up to a maximum loan amount and secured by a mortgage or deed of trust and usually with recourse to the developer.

Default

Failure to perform any term or condition of the loan; most commonly missing interest and principal payments; it can lead to acceleration and foreclosure.

Workouts and Extension Agreements

Lender-preferred alternatives to foreclosure that extend the maturity date or lengthen amortization or temporarily reduce payments but do not permanently cut the rate or balance.