Real Estate Terms and Concepts: Appraisal, Depreciation, and Financing

Absorption

The rate at which land or buildings will be sold or leased in the marketplace during a predetermined period of time, usually a month or a year. Also called "market absorption."

Accelerated Depreciation

A method of calculating depreciation in which greater amounts of depreciation are charged off in the earlier years rather than in the later years of the life of the asset. Contrast with "straight-line depreciation." See Straight-Line Depreciation.

Accelerated Clause

A clause in a mortgage or trust deed that gives the lender the right to cause the outstanding balance to become immediately due and payable upon the occurrence of a certain event, usually a payment default or the sale of the property.

Accommodation Party

One who guarantees the note of another without receiving valuable consideration.

Accrued Interest

Interest earned but not yet paid.

Ad Valorem

According to value. Used in reference to general property tax, which is usually based on the official valuation of property.

AIREA

See American Institute of Real Estate Appraisers.

All-Cash Value

The price of a property for which a cash payment is made in full upon transfer of title, as opposed to the price for the same property when payment is made in installments after a down payment.

All Inclusive Trust Deed

See Wraparound Mortgage.

American College of Real Estate Consultants (AREC)

A national professional and trade association of individuals involved in real estate consultation, sales, accounting, law, education, finance, and government. Designations include Certified Real Estate Consultant (CREC).

American Institute of Real Estate Appraisers (AIREA)

A national professional and trade association of appraisers. Designations include Member Appraisal Institute (MAI) and Residential Member (RM).

American Society of Real Estate Counselors (ASREC)

A national professional and trade association of Realtors whose members provide counseling services for a fee rather than for a commission. Affiliated with the National Association of Realtors. Designations include Counselor of Real Estate (CRE). See also Realtors.

Amortization

The liquidation of a financial debt through regular periodic installment payments; for tax purposes, the periodic deduction of capitalized expenses, such as organization costs.

Amortization Schedule

A schedule listing the due dates of required payments on a debt obligation and the reduction in principal accompanying each payment. Also called "curtail schedule."

Annual Constant Rate

See Constant.

Annuity

An amount payable annually or at other regular intervals that is a part of a series of periodic payments.

Anticipation Theory

The real estate theory that the worst property in an area will accrue greater appreciation because it is surrounded by properties of greater value. Often used with reference to houses in specific neighborhoods.

Appraisal

The estimation and opinion of value placed on a piece of property by a qualified expert; the process of estimation and the report itself.

Appraiser

A qualified person hired to estimate the value of real and personal property.

Appreciation

An increase in value.

Assessed Value

A valuation (usually a fraction of the market value) placed on property by a public official (usually the tax assessor) as a basis for taxation.

Assumption Agreement

An agreement in which a party agrees to assume or take over the obligations originally incurred by another.

Assumption of Mortgage

The taking of title to a property by a grantee who assumes liability for the payment of an existing note secured by a trust deed or a mortgage, thereby becoming personally liable for payment of the note and performance of the trust deed or mortgage. Also called "loan assumption." See also Subject to Mortgage; Substitution of Liability.

Balloon Payment

The last installment payment (whose amount is substantially larger than prior installments) that terminates a debt.

Band of Investment

A method of establishing a capitalization rate by determining the percentage of the total rate that relates to each investment return element.

Band of Investment Example

Equity .20 of total investment x .30 earning rate = .06 Loan as percent of investment .80 x loan rate .09 = .072 Capitalization rate, band of investment method = .132 or 13.2%

Basis

See Tax Basis.

Basis Points

One one-hundredth of one percentage point (.001 %).

Benefit-Cost Analysis

See Cost-Benefit Analysis.

Bid Bond

A bond that compensates the owner for the difference between the low bid and the next lowest bid if the low bidder fails to enter into a contract.

Blanket Mortgage

A single mortgage that covers two or more parcels of real estate.

Blighted Area

An area of seriously declining property values.

Board Foot

A unit of measure used for lumber; any combination of thickness, width, and length, using nominal dimensions, that equals 144 cubic inches (e.g. 2 x 6 x 12 inches or 1 x 12 x 12 inches).

BOMA

See Building Owners and Managers Association International.

Boot

Dissimilar property (or cash) included as part of the consideration in an exchange of real property to compensate for a difference in value.

Breaker

In shopping-center leases, the level of tenant sales required for landlords to begin receiving overage rents, taking into consideration minimum rents paid and offsets for tenant expenses, such as taxes and insurance. Often calculated on a square-foot basis. Also called "break point."

Building Owners and Managers Association International (BOMA)

A national trade association of office and apartment building owners and managers.

Burn Off

To amortize any front-end payments, such as prepaid interest. See Front-End Money.

Buyer's Closing Costs

The costs of completing a purchase transaction that are the responsibility of the buyer. See also Proration.

Buy-Out Estimate

An estimate of the total cost of a structure based on the costs of contracts for work that already has been awarded.

Capitalization

A process of determining the value of real property in which project income is divided by a predetermined annual rate (capitalization rate). For example, a building with annual project income of $100,000 is worth $1,000,000 at a 10 percent capitalization rate ($1 00,000/10% = $1,000,000). See Capitalization Rate.

Capitalization Rate

The rate that is considered a reasonable return on and of investment (on the basis of both the investor's alternative investment possibilities and the risk of the investment).

Used to determine the value of real property through the capitalization process

Also called 'free and clear return." See Capitalization; Return of an Investment; Return on an Investment.

Carrying Charges

Various costs that are incidental to property ownership (e.g., taxes, insurance costs, and maintenance expenses).

Cash Flow

Cash received during a certain time period from an investment after all cash operating expenses, debt service, and an allowance for income taxes have been deducted from the gross income. Cf, Equity Income.

Cash-On-Cash Return

See Simple Return.

Ceiling Price

The maximum price that a buyer is willing to pay for a piece of property.

Certificate of Reasonable Value

A certificate granted by a federal employee after physical inspection of a property. Required for FHA and VA loans to determine the loan/value ratio.

Commingled Fund

A fund of investment capital, normally sponsored by an insurance company or commercial bank, that offers pension and profit-sharing trust accounts an opportunity to invest in real estate equities on a "pooled" basis.

Commitment Fee

A fee paid by a potential borrower to a potential lender who agrees to make a loan at some future time. Most often expressed as a percentage of the future loan amount and referred to as "points." See Points.

Comparables

Recently sold or leased properties similar to a property being appraised. Used in establishing a fair market value under the market approach to value. See Fair Market Value; Market Approach to Value.

Compensating Balance

A percentage of the original principal of a loan that must remain in the borrower's account. A compensating balance requirement reduces the funds available for use and raises the effective interest rate. See also Link Financing.

Completed Contract Method

A method of reporting income only upon completion of a construction contract. Contrast with the Percentage of Completion Method.

Compound (Compound Interest)

To provide an interest (or earning) rate on a periodic basis and to periodically add the earnings to the fixed amount already invested. In other words, interest is paid not only on the original investment but also on any amounts added to that original amount through previous interest payments.

Constant

The annual payment, including both principal and interest, expressed as a percentage of the total loan value required to amortize a loan in a given period of time at a given rate. For example, the constant required to amortize an eight percent 30-year loan is 8.81. Also called "annual constant rate."

Construction Costs

The costs associated with the improvement of raw land but not including costs of the land, financing, or sales.

Construction Loan

A form of interim financing, usually disbursed in installments. Used to finance the actual construction of improvements upon a piece of land. See Gap Financing; Interim Financing; Takeout Loan.

Consumer Price Index (CPI)

An index, published by the federal government, measuring the change in the cost of a variety of goods and services. Often used in loans and purchase agreements to adjust future rent payments or purchase prices for the effects of inflation. Also called "cost-of-living index."

Contingent Interest Mortgage

A mortgage whose interest rate is tied to the economic performance of the property.

Contract Documents

Working drawings and specifications indicating to the contractor the exact manner by which a project should be built. See Preliminary Design; Schematic; Specifications; Working Drawings.

Contractor's Overhead Costs

The costs of construction incurred by a contractor that are not direct costs (i.e., labor or materials), including office expenses and equipment.

Contract Rent

The rental payments stipulated in a lease or rental agreement. See also Economic Rent.

Conventional Loan

A mortgage loan that is privately financed without governmental insurance or guarantees (i.e., a loan other than an FHA or a VA loan).

Correspondent

An agent of a financial institution who analyzes and services loans originating in the agent's local area.

Cost Approach To Value

See Replacement Approach to Value.

Cost-Benefit Analysis

An analytic technique that weighs the costs of a proposed project against the expected benefits. Also called "benefit-cost analysis."

Cost Certification

An audited statement required from FHA-insured housing projects.

Cost-Of-Living (COL) Index

See Consumer Price Index.

Cost-Plus-Fixed-Fee Contract

A construction contract in which the contractor is reimbursed for actual costs incurred and also receives a predetermined fixed fee, usually used when the exact nature of the project is not known. See also Fixed-Price Contract; Guaranteed-Maximum-Price Contract.

CPI

See Consumer Price Index.

CPM

See Critical Path Method; Institute of Real Estate Management - CPM.

CRE

See American Society of Real Estate Counselors.

Critical Path Method (CPM)

A management tool for scheduling and monitoring construction activity based on the step-by-step breakdown of a job into its component parts, the plotting of sequential relationships, and the time and lead time required for all operations. Can be done manually or with a computer, depending upon the job's complexity. See also Program Evaluation and Review Technique.

Crossover Phenomenon

The situation that occurs in connection with highly leveraged properties when the increasing principal payments finally exceed the decreasing depreciation and interest charges. From this point on, taxable income will normally exceed cash flow.

Curable Depreciation

The deterioration of property due either to physical wearing out or obsolescence. Can and should be corrected by the owner through repair and replacement.

Curtail Schedule

See Amortization Schedule

Curtain Walls

Exterior walls not providing major structural support, usually composed of glass, aluminum, ceramics, or other light building materials.

DCF

See Discounted Cash Flow.

Debenture

A form of, or another name for, a bond that is not secured by any specific mortgage or lien but rather is based on the credit of the issuing authority.

Debt Service

The periodic payments consisting of principal and interest required to amortize a loan. See also Constant.

Declining Balance

A form of accelerated depreciation that allows the owner to apply a uniform rate to the unrecovered basis in the property. The rate used cannot exceed double the straight-line rate, and the property cannot be depreciated below its salvage value. For example, a property with an economic life of 50 years would have a straight-line depreciation rate of two percent.

Assuming a depreciable basis of $100,000, the maximum annual depreciation using the declining balance method would be as shown in the following table:

Declining Balance Table

Year Rate(%) Unrecovered Basis Annual Depreciation

1 4 x $100,000 = $4,000

2 4 x 96,000 3,840

3 4 x 92,160 3,686

4 4 x 88,474 3,539

5 4 x 84,935 3,397

The same approach can be used in calculating depreciation at lesser multiples of straight-line depreciation such as 125 percent or 150 percent. See Accelerated Depreciation.

Deep Shelter

Tax shelter in excess of project income used to offset taxable income from other sources. Generally produced by deducting expense items associated with future income production (e.g., accelerated depreciation or prepaid interest) or construction period write-offs of property taxes and interest. Its use is severely restricted by recent tax legislation.

Deferred Maintenance

Maintenance or repair of property that is postponed or neglected.

Deficit Financing

Financing arranged when the net income from a piece of income property is not sufficient to cover the costs of financing the purchase.

Demography

The statistical study of the characteristics of populations, such as size, distribution, density, age, and income.

Depreciation

In real terms, a loss in the usefulness, and therefore value, of an asset. Most commonly used to describe a tax-deductible expense (although not cash expenditure) that is intended to approximate the actual loss in usefulness overtime.

See also Accelerated Depreciation; Straight-Line Depreciation.

Design Efficiency

The trade-off between a more merchandisable product and higher costs of structural construction; the analysis needed to achieve the highest ratio of net rentable area to gross building area.

See Gross Building Area; Net Rentable Area.

Deterioration

A decrease in the value of property due to wear and tear.

Discount

Assuming assets to be received in the future will have values lower than in the present, a discount is an estimate of the value today of a single amount or a series of periodic amounts to be received at a known time in the future. The difference between the current and future values of the asset is expressed as a percentage, also known as the "discount rate;" the sale of a note for less than its face value, thus providing an interest rate to the buyer that is higher than the stated rate.

Discounted Cash Flow (DCF)

A method of analyzing investment opportunities by which future cash flows are discounted and cumulated to arrive at their net present value or internal rate of return. See Internal Rate of Return; Net Present Value; Present Value.

Disintermediation

The removal of funds by savers from financial intermediaries (e.g., savings and loan associations, banks) for direct investment in financial instruments (government and corporate bonds). Occurs when the interest rates available on direct investments are significantly higher than the return offered by the financial intermediaries.

Economic Life

The period over which a property will return a profit sufficient to justify its continued operation.

Economic Obsolescence

The decline in a property’s value caused by external forces, such as zoning changes or the decline of the neighborhood. See also Functional Obsolescence; Physical Obsolescence.

Economic Rent

The fair market rent that a property would earn at a particular point in time, usually during an appraisal. See also Contract Rent.

Effective Second Lien

The difference between the amount of an all-inclusive trust deed (or wraparound mortgage) and the underlying first lien. See Wraparound Mortgage.

Equity

The value of one's interest in a property, consisting of its fair market value less any outstanding debt or other encumbrances.

Equity Income

The amount of pretax cash accruing to equity investors. Calculated by subtracting monthly or annual debt service from project income for a similar period. Also called "net spendable income," "pretax cash flow," and "spendable income."

Equity Kicker

See Equity Participation.

Equity Participation

The participation by a lender in the equity ownership of a project as one of the conditions for granting a loan. Used by financial institutions to partially offset the effects of inflation. Also called "equity kicker."