A tax term that refers to the act of selling one investment property and then buying another with the proceeds in order to avoid paying capital gains taxes on the sale. This allows your real estate investments to continue growing tax-deferred and allows you to continue to put all of your real estate profits to work for you, as opposed to paying capital gains taxes after every property sale. In order to take full advantage of a 1031 exchange, the second (newly-acquired) property must close within 180 days of the sale of the first property and be of equal or higher value. Please review our guide to 1031 exchanges for more information.
With an absolute net lease, tenants are responsible for virtually every possible payment, including major repairs. Triple net leases generally have a few maintenance-related limitations. For example, if a building has structural issues because of its age, that may still fall to the landlord under a triple net lease. Under an absolute net lease, it would be the tenant’s responsibility.
Individuals who have a net worth of over $1 million (excluding the value of a primary residence) or have an annual income of $200,000 or more for the past two years filing individually -- $300,000 or more if married filing jointly.
Active Adult communities are 55+ communities that offer independent living options for seniors. Active Adult has replaced retirement communities in the nomenclature because many of the people who move to these communities are not retired. These can be townhouses, condos, or single-family homes within a community. Most units in active adult communities are owned by the residents although the percentage of renters is growing.
Adaptive reuse is the process through which a building is updated or modified for a new user. An example of this would be when a former warehouse is converted into residential lofts. Adaptive reuse has become popular as industrial neighborhoods are transformed into mixed-use developments.
The annualized rate of return takes the total rate of return and divides it by the number of years held in order to determine the rate per year. This is useful in calculating returns over time. The overall rate of return is the gain or loss a property generates minus the initial costs.
An opinion of value from a licensed broker often used by banks, lending institutions, and real estate investors. BPOs can be calculated based on the interior of the home or solely on the exterior condition.
Capital calls, or additional capital contributions, are rarely used provisions in private equity real estate partnerships that grant the sponsor or general partner the power to seek additional capital from investors or limited partners on top of their existing equity commitment. In real estate, capital calls are almost always made when a property has entered a state of distress. The property’s net operating income has become impaired due to lower occupancy or some other situation, threatening its ability to meet working capital needs and service its debt.
If allocated properly, capital calls can help a property or development project remain viable and avoid worse outcomes for investors, such as bankruptcy or an acquisition or recapitalization at a sharply lower valuation. Either scenario would almost surely wipe out equity holders. Moreover, capital calls are almost always less costly and more efficient sources of capital than raising new debt or equity, which can sometimes be difficult to come by and come with onerous terms that are more punitive to existing equity holders.
Income earned when an asset is sold for more than its purchase price. Capital gains are taxed at different rates depending on if it's a short-term capital gain or long-term capital gain. Short-term capital gains apply to assets owned for a year or less.
This is the legal structure of all the financing sources that make up the purchase of a commercial real estate asset, as well as any improvements that are subsequently made to the property. Generally, the most senior form of financing is on the bottom of a capital stack, and more subordinate types of debt are “stacked” on top of it. For example, senior debt is often the most high-priority type of debt (on the bottom) in a capital stack, and is often followed by mezzanine debt, preferred equity, and common equity. Generally speaking, the higher you are in a capital stack, the higher your risk level.
Short for “capitalization rate,” a property’s cap rate is the amount of net operating income, or NOI, a property is expected to generate, expressed as a percentage of its acquisition cost or current market value. For example, if a certain property is expected to generate $60,000 in net operating income and it cost $1,000,000 to acquire the property, its cap rate would be 6%.
Also known as “cash yield,” this is the property’s net operating income divided by the actual dollar amount you invest in it. For example, if your actual out-of-pocket cost to acquire a certain property is $500,000 and it generates $50,000 in NOI, your cash-on-cash return is 10%.
The Central Business District of a town is its commercial and business heart. Projects that are near or in a CBD are often desirable because the demand for office space is likely to remain strong. Overall vacancy rates for a CBD can also indicate the general health of a city’s economy.
Office buildings and other facilities are rated using an informal system that looks at the condition of a building, location, amenities, infrastructure and technology capabilities to determine how well the building rates. Class A buildings have updated interiors and are in prime locations while Class B buildings are generally at least 10-20 years old and may represent a value-add opportunity for investors. Class C buildings are at least 20 years old and will likely require significant renovation.
Co-living is a type of leasing arrangement in which residents lease a generally smaller bedroom or apartment but share larger common areas. Some co-living apartments also include services such as housekeeping and all utilities as part of a single lease. Co-living arrangements are very common in student-focused housing and can also be seen in some senior communities.
A tangible asset that holds value, such as a vehicle or property, that secures a loan. Most banks require borrowers to pledge some type of collateral to be approved for a loan. If you get a home loan, the property you're buying is the collateral. If a borrower defaults on a loan, the bank takes possession of the collateral.
Recently sold properties that are similar in size, age, location, and features to the subject property. These are used to help derive a likely sale price.
The Compound Annual Growth Rate looks at the total time an investment is held and the total return to determine the rate of increase. CAGR is a less complex calculation than the Internal Rate of Return calculation (IRR) because it does not take multiple cash flows into account.
A seller-financed loan in which the seller or owner of the property provides financing for the buyer. The seller receives monthly payments over time and remains on the property title until the buyer fulfills their contract, when the property is given to the buyer. This can also be called an agreement for deed, installment contract, or land contract.
While a core investment is generally considered the most solid, a core-plus investment adds a little more risk but a higher rate of expected return. Core plus sits between core investments — the most secure and stable real estate investments — and value-add investments on a continuum of risk vs. return.
As the name implies, cost of capital refers to the cost of a company’s funds. In economic terms, this means the rate of return that an investor could have earned by putting money into a different investment with a similar risk profile -- so it’s the return that’s necessary to attract capital. For example, a company’s cost of debt capital is calculated by adding a risk premium to the rate a similar-duration risk-free bond is paying.
A process in which parts of a property are depreciated faster rates than others. For example, the roof, windows, or HVAC system can be depreciated at different rates than the building itself.
The generic definition of crowdfunding is raising relatively small sums of money from a number of people in order to finance a project or investment opportunity. In real estate, crowdfunding platforms allow investors to pool their money to invest in commercial properties.
A platform on which accredited investors can connect with approved sponsors and specific investment opportunities.
Debt coverage ratio (DCR) -- Also known as debt service coverage ratio, or DSCR, this is an expression of a property's operating income relative to its debt obligations. When you buy a primary residence, lenders tend to consider your personal debt-to-income ratio, employment situation, etc. With investment properties, the income generation of the property plays a much larger role. In other words, lenders want to know that the property will generate enough rental income to comfortably pay the mortgage and all other expenses. For example, if a property generates $5,000 per month in net operating income and there's a $4,000 per month mortgage payment, this is a DSCR of 1.20. Higher is better, and a more favorable DSCR will typically qualify you for better borrowing terms.
Many REITs report their debt-to-capitalization or debt-to-total capitalization in order to express their leverage. For example, if a REIT has $3 billion in debt and the value of its outstanding common and preferred stock is $7 billion, this would imply that its debt is 30% of its total capitalization. REITs with relatively high debt-to-capitalization ratios are generally considered to be riskier than their lower-leverage counterparts.
This is a valuable way to assess a company’s ability to repay its debts. Debt-to-EBITDA tells investors how long it would take a company to repay all of its debt obligations. For example, a company with $10 millions in EBITDA last year and $50 million in debt would have a debt-to-EBITDA ratio of 5. For REITs, debt-to-EBITDA is also useful for comparing the leverage of different REITs to help assess the risk level of each.
The percentage of a consumer's income allocated to paying debts. Calculated by dividing monthly debt payments by monthly income. Debt-to-income ratio is often used by lenders when approving a loan.
When you purchase certain business assets, you can immediately deduct their entire cost. On the other hand, some assets have to be deducted over a number of years, through a process known as depreciation. Real estate is an example of an asset that is depreciated over time for tax purposes. This makes traditional methods of calculating earnings less effective for real estate investments. After all, depreciation is essentially a “loss” for tax purposes, even though the value of the property doesn’t necessarily decline each year – in fact, the opposite is generally true.
Financial assistance that increases the down payment a home buyer can put toward the purchase of a property.
Stands for earnings before interest, taxes, depreciation, and amortization. EBITDA is considered to be a good indicator of a company’s operating profitability. EBITDA is also often used in conjunction with a company’s debt level to assess how leveraged the business is relative to its profitability.