Below are some important terms that every person in the myriad fields of real estate should know; however, this by no means encompasses all the different terms and definitions that are important to know.

Appreciation

The increase in the value of a property or a real estate portfolio due to changes in macro conditions such as economic growth, inflation, or numerous other causes is called appreciation. The opposite is depreciation.

Bidding War

A bidding war is a situation in which two or more potential buyers of a property or portfolio compete for that ownership through incrementally increasing bids.

Capitalization Rate (Cap Rate)

A cap rate, also known as the yield or yield on cost, is one the preeminent concepts used in commercial real estate. It is basically the return on a property based on the income that the property is generating. The cap rate of an investment can be calculated by dividing the property’s net operating income by the current market value or acquisition cost of a property. Here is the formula:

Capitalization Rate = Annual Net Operating Income / Property Value

Let´s use a simple example. Let’s say that Jose wants to buy an apartment for $100,000 and expects that it will generate an annual net operating income of $9,000. The cap rate for this investment would be 9.0 percent ($9,000 / $100,000 = 9.0%).

Or let’s say that Company X wants to buy an office building for $100 million that is generating an annual net operating income of $6 million. The cap rate for this investment would be 6.0 percent.

Central Business District (CBD)

A central business district is the commercial and business center of a city. Sometimes it is also known as the financial district.

Comparables (Comps)

Comparables are used to determine the value of an asset based on a recently sold similar asset. The idea is that recent sales of similar assets will likely reflect the current market for the asset and be a good indicator of the possible sale price for that specific asset. This technique is often used to determine the initial sale price of a property. It is one of several different ways to value a property.

Common Area Maintenance (CAM)

Common area maintenance is the cost that a landlord pays to operate and run its commercial property. CAM usually includes charges for cleaning up common areas, security, property taxes, insurance, repairs, and maintenance.

Commercial Mortgage-Backed Security (CMBS)

A CMBS refers to a type of mortgage-backed security that is backed by a commercial mortgage instead of by residential real estate.

CMBSs are complex securities and require a wide range of market participants. Among some of the entities involved with CMBS are servicers (primary, master and special), investors, rating agencies, and trustees. Each of these market participants has a different role to ensure that the CMBSs function properly.

Commercial Real Estate

Commercial real estate refers to property that is income producing. Commercial real estate includes office buildings, industrial and logistical centers, medical centers, hotels, shopping centers, retail stores, farm land, multifamily housing buildings, warehouses, and garages.

Construction Loan

A construction loan is short-term loan given to a company to finance the construction of a real estate project. The lender makes proceeds to the developer at periodic intervals as the work progresses. Because they are considered somewhat risky, construction loans usually have higher interest rates than traditional loans.

Closing

A closing refers to the meeting that takes place where the sale of a property or portfolio is finalized. At the closing meeting, buyers and sellers sign the final documents, and the buyer makes a payment and covers closing costs.

Depreciation

A decline in the value of property due to macro factors and other causes is called depreciation. The opposite is appreciation.

Discounted Cash Flow (DCF)

DCF analysis is widely used in real estate and is a method of valuing a project using the time value of money concept. It uses future free cash flow projections and discounts them, using an annual rate, to arrive at present value estimates. It is a useful analysis to determine how much to pay for a property (or portfolio) and it’s also useful to determine whether a given project will be a good investment or not. Remember, however, that this analysis is only as good as the assumptions you use for projections.

Due Diligence

Due diligence refers to an investigation or audit of a potential property, portfolio, or company to confirm that the facts being reviewed are satisfactory to the group performing the inquiry. The goal of a due diligence in real estate is to ensure that all the fundamentals are in order, such as all legal documents, tax structures, any potential lease agreements, any obligations, market information, and more.

EBITDA

EBITDA—earnings before interest, tax, depreciation and amortization— is a measure of a company’s operating performance. It is basically a way to evaluate a company’s performance without having to account for any issues related to financing, accounting or tax.

Equity

Equity means ownership. The more equity you have, the more financial flexibility you have, as you can refinance against whatever equity you’ve built. Here is an example: if you recently acquired a $50 million building, and you owe $25 million to the bank, you have $25 million in equity.

Equity Multiple

An equity multiple is defined as the total cash distributions received from an investment, divided by the total equity invested. For example, if the total equity invested into a project was $1 million and all cash distributions received from the project totaled $1.6 million then the equity multiple would be $1.6 million / $1.0 million or 1.60x. Having an equity multiple at less than 1.0x means you are getting back less cash than you invested. An equity multiple greater than 1.0x means you are getting back more cash than you invested.

Fixed-Rate Mortgage

A type of loan in which the interest rate does not change during the entire term of the mortgage is called a fixed-rate mortgage.

Foreclosure

The legal process in which borrowers who have defaulted on their loans lose their ownership in the mortgaged property is called foreclosure. This process usually involves a forced sale of the property; and the proceeds of the sale are usually first taken by the lender so that they recoup their loan plus interest.

Flipping

Flipping refers to purchasing an asset with the intent of selling it for a quick profit rather than holding on to it for long-term appreciation. This term is usually associated with flipping homes.

Floor-to-Area Ratio (FAR)

The floor-to-area ratio is the relationship between the total amount of usable floor area that a building currently has, or is allowed to have, and the total area of the land parcel on which the building stands. This ratio is determined by dividing the total floor area of the building by the gross area of the land parcel. For example, a FAR of 10 for a property that has 1,000 square feet would mean that you could build 10,000 square feet of urban construction. Governments around the world use the floor-to-area ratio in zoning codes.

Funds from Operations (FFO)

Funds from operations refer to a calculation used by REITs (real estate investment trusts) to show cash flow from their operations. FFO is calculated by adding depreciation and amortization to earnings and then subtracting any gains on sales.

Ground Lease

A ground lease involves leasing land, typically from anywhere between 50 and 99 years, to a tenant who comes and constructs a building on the property. The ground lease defines who owns the land and who owns the building and improvements on the property.

Hard Costs

Costs associated with the physical construction of the building (and any fixed equipment in it) are called hard costs. They can be related to the building’s structure, the landscape, labor and materials, and other building-related equipment. In terms of the building site, all utilities, equipment, HVAC systems, paving, and grading are considered hard costs. Those associated with the landscape are based on the architectural drawings and include grass, trees, mulch, fertilizer, and the like. The range of hard costs varies widely around the world but tends to be most expensive in global cities such as London, Hong Kong, Tokyo, San Francisco, New York, for instance.

HVAC

HVAC stands for the heating, ventilation, and air conditioning systems used to heat and cool buildings. HVAC systems have become the required industry standard for construction of new buildings.

Interest-Only (IO) Loan

With an IO loan the borrower only pays the interest on the mortgage through monthly payments for a term that is fixed, usually between 5 and 7 years. After the term is over, many borrowers look to refinance their assets, make a lump sum payment, or begin to pay off the principal of the loan.

Initial Public Offering (IPO)

An IPO is a type of public offering in which shares of a company are sold to institutional and retail investors in the public markets. An IPO is usually underwritten by at least one investment bank, which also arranges for the shares to be listed on one or more stock exchanges.

Internal Rate of Return (IRR)

The internal rate of return is a way of calculating rate of return by excluding external factors, such as cost of capital, inflation, and others. It is also called the discounted cash flow rate of return.

Liquidity

Liquidity in real estate describes the measure in which an asset can be quickly bought or sold in the market without affecting the asset’s price. Cash is always considered to be the most liquid asset while real estate is generally considered illiquid.

Letter of Intent (LOI)

An LOI is a document outlining one or more agreements between two (or more) parties. The document is similar to a term sheet or memo of understanding. Such an agreement may be used for a leasing agreement, a joint venture partnership, an acquisition, as well as other purposes.

Lease

A lease is a legal contract that includes the terms of rental agreements in real estate. For example, a person who wishes to rent a house has to sign a lease that will describe the monthly rent, payment dates, the duration of the lease, and numerous other important terms. The landlord requires the tenant to sign the lease before inhabiting the property. While leases in the residential sector are usually one year, leases in the commercial space are longer—and more complex—usually between 3 and 10 years.

Loan-to-Cost (LTC)

The LTC is a percentage used in real estate construction to compare the amount of the loan used to finance a project to the cost of building the project. If the project costs $100 million to complete and the borrower borrows $60 million, then the loan-to-cost (LTC) ratio would be 60 percent. The costs included in the $100 million cost number would be the land parcel, construction labor and materials, as well as most of the soft costs.

Loan-to-Value (LTV)

An LTV is a percentage relationship between the amount of the loan and the appraised value or sales price (whichever is lower). For example, if you buy a house that costs $100,000 and you obtain 60 percent acquisition financing, your LTV would be 60 percent.

Lock-Up Period

A lock-up period is a window of time in which investors are not allowed to exchange or sell shares. In real estate, the lock-up period helps equity investors or lenders avoid liquidity problems while capital is put to work in investments that are considered less liquid.

Loan

A loan is a legal document that pledges a property to the lender as security for payment of a debt. Instead of mortgages, some states use First Trust Deeds.

Loss Factor

Loss factor is defined as the percentage difference between the rentable or the sellable area and the usable area. A building with a sellable area of 500,000 square feet and a usable area of 400,000 square feet, for example, has a loss factor of 20 percent.

Mezzanine Financing

Mezzanine financing is a hybrid form of lending sandwiched between the senior debt and equity, and it gives the lender the right to convert to an equity interest in the property in case of default after the senior lender is paid. It is the highest-risk form of debt; a typical interest rate for mezzanine financing is 12 to 20 percent, making it not only a high-risk but also a potentially high-return form of financing.

Example: Suppose a real estate investment firm wants to buy a building for $100 million. A senior lender only wants to lend 60 percent of the value of the building, $60 million. The fund doesn’t want to put up all the remaining $40 million, so it finds a mezzanine investor willing to lend them $15 million. With $75 million in combined debt financing, the investment firm now only needs to contribute $25 million of its equity to purchase the building. This increases the buyer’s potential return while minimizing the amount of capital it has to dedicate to the transaction; however, it also increases the risk the buyer is taking on to do the deal.

Net Operating Income (NOI)

Net operating income, also known as NOI, is a calculation used to analyze commercial real estate investments. NOI equals all revenue from the property minus all reasonably necessary operating expenses. NOI is a before-tax figure that excludes principal and interest payments on loans, capital expenditures, depreciation, and amortization.

For example, a property that has $100,000 in annual revenues and $27,000 in operating expenses, the NOI calculation is: $100,000—$27,000 = $73,000 NOI. Now let’s break that down a little further.

Net Present Value (NPV)

Net present value is the value of all future cash flows (positive and negative) over the entire life of an investment discounted to the present. NPV analysis is a form of valuation used in real estate to measure the worth of a company, portfolio, or project.

Real Estate Agent

Real estate agents are licensed professionals who arrange—and many times help negotiate—the buying, selling, and leasing in real estate transactions. Agents usually work completely on commission, so their income depends on their ability to assist clients and close transactions.

Recourse Loan

A recourse loan allows a lender to seek damages if the borrower fails to pay back the mortgage and if the value of the underlying asset is not enough to cover it. A recourse loan allows the lender to go after all the assets that the borrower placed as collateral in case of default. It is not advisable for anyone to ever take a recourse loan.

REIT

A real estate investment trust (REIT) is a company that owns, and in most cases operates, income-producing real estate. REITs own many types of commercial real estate, ranging from commercial office and shopping centers to multifamily apartment buildings, warehouses, hotels, hospitals, and more. For a company to qualify as a REIT, it must meet certain regulatory guidelines. REITs often trade on major public stock exchanges and provide investors with a way to invest in real estate in a more liquid form.

Refinancing

Refinancing is the process of replacing an existing loan with a new one. It usually results in a borrower obtaining more favorable terms, primarily a lower interest rate or a renegotiated number of years to repay the loan, from the lender. Borrowers, by refinancing, can cash out and recover some of the original investment in the asset or portfolio they acquired.

Replacement Cost

The cost to replace a real estate asset includes all land costs, hard costs, and soft costs.

Soft Costs

Soft costs include architectural and engineering fees, legal and fiscal fees, permits and license costs, development fees, building maintenance, insurance, security, and other fees associated with the asset’s upkeep. In any ground-up development there are land and hard costs as well as soft costs.

Sweat Equity

Sweat equity refers to any contribution to the development or repositioning of a property in the form of labor or services, rather than cash. The person who contributes this labor will get equity in the deal in exchange.

Title Insurance

Title insurance protects the buyer (via the owner’s policy) or the lender (via the lender’s policy) against loss arising from disputes over ownership of a property.

Triple Net Lease

A triple net lease is a lease agreement that labels the tenant as the responsible party for covering all the costs relating to the leasing of the asset. Therefore, in addition to paying rent, the lease also requires the tenant to pay the net amount of common area maintenance, real estate taxes, and building insurance.