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Glossary of Terms

The following is a glossary of real estate terms, copied directly from Financial Analysis for Commercial Investment Real Estate – Reference Manual, as published by the Commercial Investment Real Estate Institute, copyright 1997.

Abatement – In a lease, the reduction or elimination of rent for a period of time. 

Accelerated Depreciation – Depreciation methods that allow a taxpayer to take faster write-offs than with straight-line during the early part of an assets useful life. 

Adjusted basis – The original cost basis of a property plus capital improvements, less total accumulated cost recovery deductions and partial sales taken during the holding period.

Amortization – The repayment of loan principal through equal payments over a designated period of time.

Annual debt service (ADS) – The total amount of principal and interest to be paid each year to satisfy the obligations of a loan contract.

Appreciation – An investment’s increase in value

Balloon payment – The final payment of the balance due on a partially amortized loan.

Capital gain – Taxable income derived from the sale of a capital asset.  It is equal to the sale price less cost of sale, adjusted basis, suspended losses, excess cost recovery and recapture of straight line cost recovery. 

Capitalization rate – A percentage that relates the value of an income-producing property to its future income, expressed as net operating income divided by price.

Cash-on-cash rate – A simple return measure.  Calculated as cash flow before taxes divided by initial equity investment.

Class life – The useful economic life of an asset set by the IRS

Compound interest – Interest computed on the original principal and accumulated interest.

Cost approach – A way to determine the market value of a property by evaluating the costs of creating a property exactly like the subject.   

Debt coverage ratio (DCR) – Ratio of net operating income to annual debt service.  Expressed as NOI divided by ADS

Depreciation – The loss of utility and value of a property

Financial leverage – The use of borrowed funds to acquire and investment

Financial risk – The possible change in an investment’s ability to return principal and income

Gross operating income – The total amount of cash generated by the operations of a property

Income capitalization approach – A way to determine the market value of an income-producing property by converting its future income stream into a single capital value

Internal rate of return (IRR) – The percentage rate earned on each dollar that remains in an investment each year.  The IRR of an investment is the discount rate at which the sum of the present value of future cash flows equals the initial capital investment. 

Lease – A contract between landlords and tenants for a possession of space for a specified amount of rent.  Leases are used for all types of properties.

Leverage – The use of borrowed funds to finance a portion of the cost of an investment

Liquidity – The ability to covert an investment into cash quickly without loss of principal

Loan-to-value ratio (L/V) – The amount of money borrowed in relation to the total market value of a property.  Expressed as the loan amount divided by the property value

Market risk – The possibility that downward market trends will reduce an investment’s market value

Negative leverage – Borrowed funds are invested at a rate of return lower than the cost of funds to the borrower.

Net operating income (NOI) – The potential rental income plus other income, less vacancy, credit losses and operating expenses

Net present value (NPV) – The sum of the present values of all future cash flows netted against the initial investment, discounted at a given rate

Operating expenses – Cash outlays necessary to operate and maintain a property

Opportunity cost – The “cost” of selecting one alternative is the benefit foregone from the next best alternative.

Passive income – Income from rental activity, limited business interests or other activities in which the investor does not materially participate

Positive leverage – Borrowed funds are invested at a rate of return higher that the cost of the funds to the borrower.

Potential rental income – The total amount of rental income for a property if it were 100% occupied and rented at competitive market rates.

Present value – The sum of all future benefits accruing to the owner of an asset when such benefits are discounted to the present by an appropriate discount rate. 

Property type – The classification of commercial investment real estate.  The four primary property types are: retail, industrial, office and residential

Rate of return – The percentage return on each dollar invested.  Also knows as yield.

Sales comparison approach – A way to determine market value by comparing a subject property to properties with the same or similar characteristics.

Sale cost – The brokerage commissions and fees, and any additional transaction costs that are incurred during the sale of the property.

Time value of money (TVM) – An economic principle recognizing that a dollar today has greater value than a dollar in the future because of its earning power.

Yield – A measure of investment performance, gauging the percentage return on each dollar invested.  Also known as rate of return.

These terms are excerpted directly from Financial Analysis for Commercial Investment Real Estate – Reference Manual, as published by the Commercial Investment Real Estate Institute, copyright 1997.

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