Glossary

Absorption rate is the rate at which available homes are sold in a specific real estate market during a given time period. The figure indicates how many months it will take to exhaust the current supply of homes on the market.

A clause in a contract that allows a lender to demand full repayment or partial repayment of an outstanding loan if certain requirements are not met by the borrower.

An accredited/sophisticated investor is anyone who:

• Has assets of at least $2.5 million; or
• Has had an income of at least $250,000 per annum over the past two years; or
• Controls a company or trust which meets the requirements of either item 1 or 2 (above).

Accrued interest is the interest on a loan accumulated over a period of time either as an expense (for the borrower) or revenue (for the lender) and paid at maturity or final payoff. In the case of some real estate debt instruments and other bridge financing, it can provide the borrower with flexibility – with respect to the repayment schedule – while offering the lender or investor a more attractive total return.

In investing, alpha (α) refers to the return on investment beyond the expected rate of return. Also called the active return, this is often attributed to an investment manager’s skill, being the result of active management rather than market conditions.

A basis point (bps) is equal to 1/100th of 1% or .01% and is a common unit of measure for interest rate changes.

In investing, Beta is a measure of the sensitivity of a security or portfolio to broad market movements. The beta of the market index is 1.0. A security with a beta of greater than 1.0 tends to rise or fall more than the market; a security with a beta of less than 1.0 tends to rise or fall less than the market. The term “beta” can also indicate the portion of portfolio returns that result from market exposure, rather than from manager strategies or skill (alpha).Alternative and private-market assets tend to exhibit lower Beta values.

A bridge loan is a short term loan that is used while a person or company gets permanent financing or removes an existing financial obligation. These are short term loans backed by collateral, typically the underlying property in the context of real estate, and have relatively high interest rates while providing immediate cash flow.

Now considered one of the four major commercial real estate asset classes, Build-to-Rent refers to properties with more than one distinct unit, suitable for multiple tenants or groups of tenants to occupy. The term may refer to apartments or even co-living spaces.

A capital call is the right of a manager of a real estate partnership or fund to request capital from investors. Capital calls are usually addressed in the partnership or subscription documents. Some capital calls are planned, while others are unexpected. Unforeseen capital calls are less common, but sometimes necessary.

Examples that will trigger a capital call include renovations that exceed budget, unanticipated repairs or capital projects, and/or a recessionary environment that stymies demand and leads to insufficient revenue to cover property expenses. When additional capital is needed, the manager will issue a notice to each investor that explains why, as well as specific guidelines for how the capital call will be handled. In the event a capital partner opts not to participate (or funds less than one’s pro rata share), the original partnership agreement governs how a partnership will handle the situation. This may include dilution of a partner’s ownership interest, or other punitive measures.

A capital improvement is a change in or restoration of an aspect of a property that will either enhance the property’s overall value, prolong its useful life, or adapt it to new uses. It is a permanent and substantial alteration that adds significant value to a property.

Capital improvements are utilized in value-add projects and are key factors in analyzing the potential of a real estate investment. When done by companies, capital improvements are often funded by capital expenditures, or CapEx.

Capital improvement projects can vary greatly depending on the rental property and whether property owners make these upgrades in common areas or tenant areas. Examples in common areas include landscaping, installing a swimming pool or elevator, remodeling the lobby, or adding more parking. Tenant-area improvements could include new appliances, adding in-unit laundry, or changing the flooring. More broadly, the installation of an HVAC system or updated accessibility features can be improvements to any commercial property.

Repairs to normal wear and tear, such as replacing a leaky pipe, and general maintenance, such as painting, are not considered capital improvements.

The capital stack refers to the legal organization of the capital invested in a project. The stack contains the most risk at the top, traveling down the stack to the position with the least risk. Higher positions in the stack expect higher returns for their capital because of the higher risk. Lenders and equity stakeholders are highly sensitive to their position in the stack. Typically, the stack is arranged as follows, though not all levels are present in all transactions:

1. Sponsor equity
2. Preferred equity
3. Mezzanine investors (hybrid debt and equity)
4. Second and other junior mortgages
5. Investment-grade first mortgages

The capital stack determines who has legal rights to certain assets and income and the priority of payment in the event of default or sale or liquidation of the property.

The debt service coverage ratio is the ratio of cash available for debt servicing to interest, principal and lease payments. In real estate, DSCR is the primary measure to determine if a property will be able to sustain its debt based on cash flow. Senior loan documents typically impose a minimum DSCR.

A Deed of Trust is a deed where the legal title to the property is transferred to a trustee which holds it as security for a loan between a borrower and a lender. The equitable title remains with the borrower but the deed is held in trust until the loan for the property is paid.

A distribution waterfall is the order in which an investment vehicle makes payment distributions. It ensures the proper allocation of returns to investors in a pooled investment. Distribution waterfalls follow a cascading structure, meaning that once one tier’s allocation requirements are satisfied, the excess funds fall to the next tier to be distributed until all capital is issued.

Downside protection is the risk mitigation of an investment losing value. Portfolio managers can minimize losses via stop-loss orders, purchasing assets that are negatively correlated to the asset being hedged, or broad portfolio diversification, among other strategies. By proactively working to prevent loss, investors can more quickly recover their portfolios and realize higher upside over time.

As an alternative asset, real estate can serve as a strong addition to a portfolio when diversifying for downside protection. Because private real estate is highly uncorrelated to the stock market, its value is not affected by the same volatility or economic downturns. This means that a portfolio will be less affected by short-term fluctuations or losses if the stock market declines, as it continues to earn dividends on the long-term investments. As investors benefit from alternative asset allocation on a high level, they can also diversify within real estate, with each additional investment further diversifying their risk profile.

Real estate also acts as a hedge against inflation, mitigating the risk of losses associated with the decreasing purchasing power of money. Because property values tend to stay on a steady upward curve over time, and higher home prices often equal higher rent, real estate investments can provide recurring income that keeps pace with or exceeds inflation in terms of appreciation. During inflationary periods, investors may consider allocating to private real estate as a method of downside protection.

An encumbrance is a claim against a property by someone other than the owner. This term encompasses a range of claims, some of which affect the value of a property and others that do not. Encumbrances may be financial or non-financial, and may affect a property’s sale, how it’s able to be used, and its marketability.

There are numerous types of encumbrances in real estate, each with its own application, but all meant to specify claims and ensure they are met. Nearly every property in the United States has at least one encumbrance, which real estate investors should take into account when analysing investments.

Examples of Encumbrance

Encumbrances come in many forms, including the following:

• Mortgage: Mortgages are one of the most common types of liens on residential properties. It serves as an encumbrance in the way that the lender, usually a bank, has an interest in the title of the property until the debt is paid off.
  
• Easement: Easements refer to a party’s right to use or improve portions of another party’s property (affirmative easements), or to prevent the owner from using or improving the property in certain ways (negative easements).
  Examples of affirmative easements include the ability of a land-locked neighbour to put an access road on the property or utility companies having the right to install and service equipment on the property. People and organizations may only utilize easements for their limited and specific purposes.
  
  Negative easements often prevent property owners from building structures that would block a neighbour’s light or view.
• Encroachment: Encroachments occur when one party that is not the property owner intrudes on or interferes with the property, either by ignoring property boundaries or by being unaware of them. Encroachments create encumbrances on both party’s properties until resolved.
  Examples include building a fence or allowing trees to grow beyond property boundaries, as well as extending structures or landscaping onto public domain (such as gardens that intrude on the sidewalk).
  
• Lease: A lease is considered an encumbrance because it gives rights to a party other than the owner to use the property in certain ways. The tenant’s rights to the property are unaffected by its sale, and the lessor’s ability to use their property is constrained by the lease agreement.
  
• Restrictive Covenant: Restrictive covenants are agreements made upon the sale of a property that the buyer must adhere to. They may require or restrict actions taken on the property by the encumbered owner. Common covenants include HOA regulations that dictate maintenance standards or paint colours and limitations on leasing. They can be as specific and arbitrary as the parties are willing to agree to.

Depending on the classification, encumbrances may affect property owners in different ways. Because they can impact a property’s value and cause problems down the line, it is important for buyers and investors to know the encumbrances that come with its sale.

The Equity Multiple of an investment is a ratio used to help understand total cash return over the life of an investment. The ratio is equity to total net profit plus the total equity invested divided by the total equity invested. Equity Multiple is one tool used to evaluate an investment opportunity, particularly investments with longer hold periods. It does not discount to present value and does not take risk or other variables into account and should not be looked at in isolation.

As you may have guessed, a ground lease – otherwise known as a “land lease” is simply a lease on a plot of undeveloped commercial land, with the tenant on the ground lease responsible for the development and use of property on the premises. 

Ground leases are typically the longest in the industry: sometimes decades long, and sometimes as long as a century or more. A ground lease is less costly for a tenant than leasing land with ready-made property already built on it, but can constitute an added monthly cost in perpetuity for the borrower. During the term of a ground lease, the tenant owns all property constructed on the land and improvements made thereto. If a ground lease expires and is not renewed, however, all construction and improvements on the land may become property of the leaseholder on the ground lease, which can increase the leaseholder’s leverage in renewal negotiations.

A ground lease can reduce barriers to entry for developers – especially in expensive gateway markets – by allowing them to begin construction without the added cost of purchasing land (or the even greater cost of purchasing land with existing, obsolete structures that must be torn down). However, a lingering ground lease can seriously detract from the value of a property many years later, once value of the property itself is established. 

Ground leases require tenants to make regular rent payments (usually monthly), like any other lease, and are typically net leases, meaning the tenant is responsible for paying property taxes, insurance, and maintenance expenses throughout the term of the lease.

The length of ownership of an asset, usually for investment real estate.

Illiquidity refers to the inability of an asset to be readily and easily converted into cash without significant loss in value. Illiquid assets tend to have lower trading volume, be unique or unusual, and take an extended period of time (longer than 72 hours) to sell. 

The loss of value in the sale of illiquid assets can stem from a few sources. Because of the individuality and lower volume of these assets, there tends to be a lack of immediately available buyers. This can prompt some sellers to slash prices in an attempt to make a quicker sale. In other cases, there are transaction costs associated with the sale. Fees and additional costs are common in complex sales that require lawyers or other experts, such as in real estate. 

Illiquid assets are also typically traded in private markets, which lack the transparency, extensive consumer knowledge, and daily pricing found in public markets. This means that they are priced as needed and more difficult to access for most investors.

Advantages and Disadvantages of Illiquidity

Illiquid investments come with a host of advantages and disadvantages for investors to consider in relation to their individual risk tolerance and portfolio strategy. 

• Portfolio Diversification: Illiquid assets present an additional layer of diversification to a portfolio, helping to balance across markets, time periods, and asset classes. 
  
• Illiquidity Premium: Illiquid investments often benefit from higher returns as a result of their longer holding periods and the level of expertise involved in transactions. While not always the case, many investors find the potential returns to outweigh the liquidity risk. 
  
• Volatility: The slow-moving nature of private markets, lack of public trading, and tangibility of assets has historically meant less volatility for illiquid assets. While public markets often see price volatility as the result of political, environmental, and economic events, such as COVID-19, long-term investments are protected by their inability to be sold. For those who can tolerate their assets being tied up during economic downturns, an allocation to illiquid assets may provide stability. 
  
• Selling Flexibility: The hallmark of liquid assets is their ability to sell quickly at fair market value. This provides investors with the flexibility to turn assets into cash in emergency situations, which real estate investors cannot do. While flexibility may be helpful in the short-term, less liquid, long-term investments can protect against losses from panic selling.
  
• Accessibility: The private market nature of illiquid assets has traditionally dictated that their transactions are primarily available to only high net worth individuals and institutional investors. However, through companies such as RealRaise, they are now a much more accessible avenue for portfolio diversification.

Income property is property that is bought or developed specifically for the purpose of generating income for its owner through leasing, renting, or price appreciation. These properties can be commercial or residential.

Industrial properties range from smaller properties, often called warehouse properties “big box” industrial properties. Industrial properties frequently have long term leases and can sometimes be build-to-suit buildings that have difficulty changing tenants without extensive modification.

Interest reserves are a common devise within real estate debt financing instruments, and are most often used in debt structures. Borrowers fund interest reserves as capital that the lender holds in a collateral account, providing another layer of security for lenders. 

These reserve accounts maybe funded in several different ways, but are typically funded in one of the two following ways:

• “Pre-funded” or Upfront: the lender initially closes and funds the loan, a portion is held back in the reserve.
  
• Ongoing: payments are made into the reserve account by the borrower at regular intervals – typically monthly – out of the cash flows from the property. In some cases, the lender will collect rent payments for the property directly into the reserve, distributing the balance above the contractually established amount back to the borrower.

Funds in an interest reserve account may be maintained as a buffer to pad the DSCR of a given loan, to fund interest payments (in part or in whole), or some combination thereof.

The rate of discount on an investment that equates the present value of the investment’s cash outflows with the present value of the investment’s cash inflows. You can think of IRR as the rate of growth a project is expected to generate. While the actual rate of return that a given project ends up generating will often differ from its estimated IRR rate, it is a useful metric to use to compare investment opportunities. IRRs can also be compared against prevailing rates of return in the securities market. IRR projections for property investments are dependent on a number of assumptions made in the project underwriting and those assumptions should be examined in conjunction with IRR. IRR, like other measures of return, also has a correlation to investment risk.

Joint ventures typically involve two parties, the sponsor or General Partner (GP) and their equity investors or limited partners (LPs), combining resources for the development of a real estate investment. The relationship between the parties is often regarded as a “marriage of convenience,” whereby each party is providing something the other doesn’t have. In joint venture real estate deals, the sponsor is generally a real estate expert or developer in charge of managing the everyday duties of the development, while the limited partner is a capital member financing a large portion of the project. The sponsor also has a deep wealth of knowledge on the local market and asset class the joint venture is investing in.

In this type of partnership, both parties remain separate entities, only liable to one another as far as the specific real estate project is concerned. Upon completion of the goal set out in the joint venture agreement, the partnership is dissolved.

A ratio used in commercial real estate construction to compare the amount of the loan used to finance a project with the cost to build the project. If the project costs $1 million to complete and the $700,000 is borrowed, the loan-to-cost (LTC) ratio would be 70%. The costs included in the $1 million cost figure would be land, construction materials, construction labor, professional fees, and permits.

Loan to cost is a primary measure of leverage used to describe the proportionate use of debt in the financing of a real estate investment or development. All else being equal, the higher the measure of leverage, the riskier the loan or investment is considered to be. Investors or lenders may also consider LTV (loan to value) or DSCR (debt service coverage ratio) closely alongside LTC.

Whether to Use loan to cost (LTC) or loan to value (LTV)?

Loan to cost expresses debt versus the total cost of a project, whereas loan-to-value (LTV) measures debt against the appraised, fair-market value of a property. In either case, a higher value indicates greater risk, all else being equal, because the borrower has proportionally less equity in the investment. In short, LTC is a better measure when evaluating a construction-heavy project – ground-up development or value-add investments with a higher degree of necessary capital expenditure.  LTV is a more apt metric to consider when evaluating a stabilized asset or core investing strategy.

The Loan-to-Value Ratio is commonly used by banks and building societies to represent the ratio of the first mortgage lien as a percentage of the total appraised value of real property. Typically, assessments with high LTV ratios are generally seen as higher risk and, therefore, if the mortgage is accepted, the loan will generally cost the borrower more to borrow or he or she will need to purchase mortgage insurance.

Mezzanine debt is a hybrid lending vehicle, commonly used by real estate developers, to secure supplementary financing. Mezzanine debt gives the lender the right to convert to an ownership or equity interest in the company if the loan is not paid back in time and in full. It is generally subordinated to debt provided by senior lenders such as banks and venture capital companies.

Net asset value is a representation of value for a mutual fund, ETF, REIT (real estate investment trust), or other investment company or fund. It is calculated as the per-share value of the company or fund’s assets minus liabilities, and can be calculated by a simple formula:

NAV = total assets – total liabilities

Unlike the second-by-second valuations of publicly traded stocks, which are traded in real-time, funds and investment companies rely on NAV as a pricing mechanism for trades or redemptions. NAV may be calculated daily, monthly, or at some other regular cadence depending on the fund.

The income stream generated by the operation of the property, independent of external factors such as financing and income taxes. A property’s yearly gross income less operating expenses.

Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyse the profitability of an investment or project. Because of the time value of money, a dollar earned in the future won’t be worth as much as one earned today. The discount rate in the NPV formula is a way to account for this.

Opportunistic properties in real estate investing are generally properties that require a significant amount of rehabilitation in order to eventually bring in market rental rates. Properties requiring a greater amount of repairs, or rehabilitation, are generally considered high risk because the property has not yet proven whether it can indeed earn the forecasted rents once it is improved. Frequently, these investments are “ground-up” developments, which bring additional risk because of the various obstacles that arise between construction and bringing the property to market. Opportunistic investing is the riskiest strategy and has the potential for the highest earnings.

Investors are pari passu if they have the same terms of investment, including the same percentage returns and equal risk of loss to their investments.

Passive real estate investing refers to the practice of investing in real estate assets without assuming hands-on management of physical assets.

In short, passive real estate investors can expect to share in the upside of high-performing equity real estate investments, but the sponsor investor will typically stand to earn proportionally more profit in order to compensate for the additional liability and effort that the active investor must assume.

Preferred Equity is a class of ownership that has a higher claim on the assets and earnings of a property than common equity, but is subordinate to senior debt. For more on how preferred equity figured into the broader picture of commercial real estate finance.

A preferred return is a mechanism for allocating cash flow to certain parties in a real estate transaction before others. Investors or partners entitled to a preferred return will receive cash flows returned by the investment before other equity investors receive any portion of the profit. Preferred returns signal that the Sponsor feels that the transaction’s performance will not only achieve, but also exceed, the level of the preferred return, because the Sponsor’s profits depend on it.

Private real estate investing refers to the practice of purchasing, investing in, or developing real estate that is transacted in private markets, rather than investing in real estate through publicly held vehicles – such as real estate investment trusts (REITs).

Because REITs are publicly traded, liquid assets, they tend to exhibit greater volatility and correlate more closely with the stock market. Private real estate investments are illiquid, with transactions occurring in slower-moving, less efficient markets. Private real estate investing returns are a function of manager skill and microeconomic factors, hence offering return potential that is less correlated with public markets. Private real estate investing is hence referred to as an alternative asset of the sort that institutional investors pursue in order to diversify away from a traditional portfolio of stocks and bonds.

Real estate crowdfunding has afforded individual investors access to private real estate investing at much lower minimums than was previously available through offline syndication.

Real Estate Investment Trusts are tax efficient entities that own or invest in income producing real estate. There are a variety of types of REITs, some are publicly traded, some are privately traded and others are privately held. REITs must comply with specialized operating rules in order to receive special tax considerations.

Real Estate Syndication is the partnership between a group of investors pooling their resources into a single investment. Organized by a syndicator, also referred to as the sponsor or general partner, who deploys the capital, syndication is an opportunity for accredited investors to earn passive income from commercial real estate without the hassles of being a landlord or property manager. The amount an accredited investor can invest is dependent on the size of the deal. 

Syndication is often used in real estate transactions through companies such as RealRaise. This is due to the amount of capital required being beyond the means of most individual investors. By pooling resources into a single fund, investors are able to own a share of a property that they might not be able to otherwise.

Benefits of Real Estate Syndication

There are several benefits to investing through syndication, most notably access to deal flow. Because they are professionally managed, syndicators are responsible for the research and underwriting that goes into finding a deal, leaving passive investors to only worry about personal due diligence and identifying offerings that fit into their investment strategy. 

Investing through real estate syndication also leads to greater diversification. With pooled capital, each investor is able to partake in deals they could not on their own, as well as gain greater exposure with more investments across different types of real estate. At the same time, they retain control over which properties their money is invested in, unlike investing through REITs. 

Real estate investment is often associated with the inconveniences of being a landlord and the need for in-depth industry knowledge. Investing through syndications, however, offers all the benefits of real estate property ownership, without the day-to-day management. Real estate investors can receive passive cash flow and tax benefits without ever dealing with the operations of the commercial property.

Refinancing is the practice of replacing an older loan with a new loan that offers better terms, such as a lower interest rate.

A “reversion”, “reversion event” or “exit” is the terminal event the concludes a real estate project, where the Sponsor or developer expects to exit the property or portfolio of properties via sale, partial sale, or refinance. In many cases, the particulars of the projected reversion impact the overall profitability of the investment to a very large extent. As such, projected cap rates at reversion – or “terminal cap rates” – are closely examined.

Sales comps (or ‘comparables’) are prices for recently-traded assets in the immediate vicinity of a target property. Sales comps provide substantiation to the investment thesis during underwriting, serving as proof points for projected sale (or exit) price. GP investors typically present sales comps as part of an offering memorandum when seeking passive investors.

Senior debt is the first level of a corporation’s liabilities which means it is paid out first, ahead of all other creditors. Senior debt is the safest form of financing for the party providing the funds. Should a corporation go bankrupt, any remaining funds, dissolved assets or other available sources of value must first repay senior debt before other creditors are able to collect.

For more on how senior debt figures into the broader picture of commercial real estate finance, please see our longer-form blog post on the capital stack.

A real estate sponsor is a principal investor in a real estate deal, responsible for sourcing the investment and executing on its business plan. In many cases the sponsor has a background in asset management and construction/development, as well as real estate finance.

Commercial real estate sponsors oversee the acquisition of a project, contract underwriting, development of marketing materials, sourcing of capital, all financial reporting, property renovations and operations, investor distributions, and eventually the property’s refinance or sale. In short, they are in charge of sourcing the property, developing the capital structure, and ultimately executing the business plan. Because sponsors do the heavy lifting, real estate investors are able to earn passive income, not taking part in any of the operations of the property they invest in.

Sponsorship involves substantial industry experience related to both the asset class and markets they operate in, including knowledge of the local markets history, leasing dynamics, project management, relationships with third-party vendors, and how to deal with all real estate investment stakeholders. Passive investors should consider the experience and track record of the sponsors on all their prospective investments.

RealRaise’s chosen model of structuring and offering secured real estate debt investment opportunities. As opposed to some other platforms, who operate as the lender, RealRaise “syndicates” portions of existing loans originated by experienced sponsors.

A Triple Net Lease (Net-Net-Net or NNN) is a lease agreement where the lessee agrees to pay all real estate taxes, building insurance, and maintenance on the property in addition to the rent fee applied under the lease. This form of lease is commonly used for commercial freestanding buildings.

Underwriting is the process by which an underwriter performs due diligence on and otherwise scrutinizes a financing request made by a Sponsor seeking funding for a real estate project to determine how much risk to accept.

Value add properties are those which require improvements but have existing income. The improvements are of somewhat higher risk, such as larger renovations or curing deferred maintenance. Investing in value-add properties is a moderate to high risk strategy (due to the nature of larger improvements to a property) with moderate to high returns.