Real Estate 306 Quiz 3

Hard Costs

Costs directly related to physical construction — concrete, steel, electrical, plumbing, including labor.

Soft Costs

Costs not directly tied to physical construction — architecture fees, financing costs, pre-development work, legal fees.

Contingency

An additional amount set aside within the construction contract or loan to cover unexpected expenses.

Guaranteed Maximum Price (GMP) Contract

Sets the maximum amount the developer will pay the General Contractor to deliver the building per plans and specs, including contractor overhead, profit, and contingency.

Change Order

An addendum to the construction contract that changes scope, specifications, or materials — typically increases the contract amount.

Retainage

An amount (typically 5–10% of each payment application) withheld by the developer to ensure the contractor completes the project per plans and specs, including punch list items.

Gross Lease

A lease in which the tenant pays one flat rate and the landlord is responsible for all operating expenses. Landlord bears all expense risk.

Triple Net (NNN) Lease

A lease in which the tenant pays base rent plus its pro-rata share of operating expenses, real estate taxes, and insurance. Risk is fully shifted to the tenant.

Percentage Lease

A lease in which the tenant pays base rent plus a percentage of gross sales as additional rent. Risk is shared — tenant pays less in slow periods, landlord participates in tenant's upside.

How Lease Type Shifts Risk

Gross lease: landlord bears all expense risk. NNN lease: risk shifts to tenant (pays taxes, insurance, operating expenses). Percentage lease: risk is shared — landlord participates in tenant's sales upside.

Tenant Improvements (TI)

A base allowance provided by the landlord to fund improvements to the leased space for the tenant.

Expense Stop

the maximum per-square-foot amount the landlord will cover for operating expenses. Tenant pays its pro-rata share of any increases above the stop. (modified gross lease)

Lessor

The landlord — the party who leases space to another.

Lessee

The tenant — the party who leases space from another.

Asset Management

Focused on the strategic and long-term goals of the owner/investor. Duties include market rent analysis, capital improvement strategy, oversight of property managers, and hold/sell decisions.

Property Management

Handles daily, weekly, and monthly operations. Duties include collecting rent, dispatching work orders, managing vendors, approving lease applications, and routine maintenance.

KPIs (Key Performance Indicators)

Quantifiable measures of performance that provide targets, track progress, and hold teams accountable. Financial KPIs: NOI, collections. Operational KPIs: occupancy rate, leasing velocity, response times.

Graaskamp's 3 Groups

Consumer (needs space), Space Producer (developer/builder), and Public Infrastructure (government/utilities). Each has unique objectives but mutual self-interest through cooperation.

Key Concern of All 3 Graaskamp Groups

Cash solvency — if any group runs out of cash, the real estate process breaks down.

Site vs. Location

Site = the physical parcel of land. Location = the site's relationship to surrounding activities and infrastructure. Location is what drives value.

Linkages

Connections between a site and nearby uses. Positive: transit, employers, schools. Negative: highway noise, industrial uses, high crime areas.

3 Types of Real Estate Problems (Graaskamp)

1. Site in search of a use. 2. Use in search of a site. 3. Capital in search of an investment.

Risk Management Techniques in Real Estate

1. Improve forecasts/market research. 2. Pool/diversify assets. 3. Shift risk via insurance. 4. Shift risk via contract. 5. Limit liability with LLCs. 6. Hedging contracts.

Cap Rate

NOI ÷ Property Value. Represents the unlevered yield an investor expects. Higher cap rate = higher risk/return; lower cap rate = lower risk/return.

Low Cap Rate

Signals high investor demand and low perceived risk. Investors accept a lower yield for stable, well-located assets. Example: Class A multifamily or grocery-anchored retail.

High Cap Rate

Signals lower investor demand and higher perceived risk. Investors require a higher yield to compensate. Example: Class B/C properties, hotels, or speculative development.

Factors That Influence Cap Rates

Property type, location quality, tenant credit, lease length, market demand, interest rates, and asset class risk.

Consequences of Poor Design

Higher operating costs, functional obsolescence, difficulty leasing, lower rents, increased vacancy, reduced tenant satisfaction, and lower overall property value and NOI.

Deed

The legal document that evidences ownership of real property. Recorded in public records. Transfers or confirms title.

Bundle of Rights

The rights included in property ownership: right to use, sell, lease, mortgage, exclude others, and transfer at death. Each right can be separated and transferred independently.

4 Governmental Powers Over Real Estate (TEPE)

1. Taxation. 2. Eminent Domain (take property with just compensation). 3. Police Power (zoning, building codes). 4. Escheat (property reverts to state with no heirs).

Promissory Note

The borrower's personal promise to repay. Contains: loan amount (principal), interest rate, repayment schedule, maturity date, and consequences of default. A personal obligation of the borrower.

Mortgage

The security instrument that pledges the property as collateral. Contains: lender's right to foreclose upon default, legal description of the property, and borrower obligations (maintain insurance, pay taxes). Recorded against the property, not the borrower personally.

Promissory Note vs. Mortgage — How They're the Same and Different

Both are required for a real estate loan. Different: the note is the personal promise to repay; the mortgage ties the collateral (property) to the loan. You can have a note without a mortgage (unsecured), but not a mortgage without a note.

Recourse vs. Non-Recourse Loan

Recourse: lender can pursue the borrower personally beyond the collateral. Non-recourse: lender's only remedy is taking the property. Most commercial real estate loans are non-recourse.

Types of Commercial Real Estate Loans

Construction loans (banks, short-term, floating rate). Bridge/interim loans (banks, debt funds). Permanent loans (life insurance companies, CMBS, agencies like Fannie/Freddie). Mezzanine loans (debt funds, subordinate position).

Key Loan Underwriting Metrics

LTV (Loan-to-Value): loan ÷ value, max ~65–75%. DSCR (Debt Service Coverage Ratio): NOI ÷ annual debt service, min ~1.20–1.25x. Debt Yield: NOI ÷ loan amount.

Expenses Deducted to Arrive at NOI

Property management fees, maintenance/repairs, utilities, insurance, property taxes, and reserves for replacement. NOI = Effective Gross Income − Operating Expenses.

Expenses NOT Deducted to Arrive at NOI

Debt service, capital expenditures, income taxes, depreciation, and TI/leasing commissions. NOI is a pre-financing, pre-tax metric.

3 Valuation Methods

1. Income/Cap Rate Approach (NOI ÷ Cap Rate). 2. Sales Comparison (comparable sales). 3. Cost Approach (land value + depreciated replacement cost).

When to Use Each Valuation Method

Income approach: income-producing properties. Sales comparison: single-family homes, land, many available comps. Cost approach: special-use properties, new construction, limited market data.

Factors That Influence Real Estate Value

Location, supply/demand, NOI potential, cap rates, interest rates, property condition, lease terms, tenant quality, demographics, and zoning.

2 Ways to Harvest Gains in Property Value

1. Sale/Disposition — sell at a profit. 2. Recapitalization/Refinancing — pull equity out via a cash-out refinance at a higher valuation.

How Leverage Boosts Return on Equity

Borrowed money lets you control a larger asset with less equity invested. Gains are measured against only the equity — amplifying returns. Example: $2M gain on $3M equity = 67% return, not 20% on the full asset value.

Preferred Return

The minimum hurdle rate of return that Limited Partners must earn before the developer/GP can earn promoted interest.

Promoted Interest (Carried Interest)

Additional return earned by the developer/sponsor/GP after Limited Partners achieve their preferred return. Rewards the GP for performance. Typically triggered at sale or refinance.

Priority of Distributions in a Waterfall

1. Lender (loan repaid first). 2. Preferred return to Limited Partners. 3. Promoted interest to Developer/GP + remaining return to LPs.