Income Property Solutions

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Glossary of Investment Property Terms


1031 exchange
Usually a real estate property (asset) is sold and the proceeds are then reinvested in a "like kind" asset. By conducting this exchange, the person (or entity) will not realize any losses or gains per Section 1031 of the Internal Revenue Code. Capital gains taxes are deferred until the property is not exchanged and only sold.

adjusted sale price
The figure produced when the transaction price of a comparable sale is adjusted for elements of comparison.

anticipation
The perception that value is created by the expectation of benefits to be derived in the future.

arm's length transaction
A transaction between unrelated parties under no duress.

assemblage:
The combining of two or more parcels, usually but not necessarily contiguous, into one ownership or use.

balance:
The principle that real property value is created and sustained when contrasting, opposing, or interacting elements are in a state of equilibrium.

capitalization rate
- The Cap Rate = Net Operating Income / Price.

For example: An apartment building with 12 units is listed for sale at $800,000. The annual rental income is $92,000 with operating expenses adding up to $35,000. If area's vacancy rate is 6%, what is the Cap Rate?

Cap Rate = ($92,000 – ($92,000 x 6%) – $35,000) / $800,000 = 6% Cap

Investors typically use the Cap Rate to measure the potential return of an investment property. For the most part, a 10% Cap Rate would suggest a 10% return on investment. Based on the estimated return, the buyer (or investor) then figures out the price they are willing to pay.

capital recovery
The return to investors of that portion of their property investment expected to be lost over the income projection period.

capital recovery rate
The return of invested capital, expressed as an annual rate; often applied in a physical sense to wasting assets with a finite economic life.

cash equivalency analysis
The procedure in which the sale prices of comparable properties sold with atypical financing are adjusted to reflect typical market terms.

combined loan to value CLTV
The ratio between two mortgage loans and the value of the property each pledged as security; commonly expressed as a percentage.

comparables
A shortened term for similar property sales, rentals, or operating expenses used for comparison in the valuation process.

comparative unit method
A method used to derive a cost estimate in terms of dollars per unit of area or volume based on known costs of similar structures that are adjusted for time and physical differences.

competition:
The active demand for real estate by two or more market participants.

consideration:
The recorded price for which title to a property is transferred.

conventional loan
A mortgage that is neither insured nor guaranteed by an agency of the federal government, although it may be privately insured.

cost index:
A multiplier used to translate a known historical cost into a current cost estimate. cost to cure. The cost to restore an item of deferred maintenance to new or reasonably new condition.

curable functional obsolescence
An aspect of accrued depreciation; a curable defect due to a flaw in the structure, materials, or design.

curable physical deterioration
An element of accrued depreciation; a curable defect caused by deferred maintenance.

DEBT SERVICE COVERAGE RATIO (DSCR)
Debt Service Coverage Ratio = Net Operating Income / Debt Service

The monthly income from a rental property after subtracting insurance, taxes, and any related operating expenses is known as the Net Operating Income (NOI). Debt Service is the monthly mortgage payment on the property. The Debt Service Coverage Ratio is an advanced type of ratio, commonly used for large loans on commercial properties. The majority of lenders will require that this ratio be a minimum of 1.10. If the DSCR is below 1.0, this would disclose that the property's income is not enough to service the debt. In essence, a negative cash flowing property.

deferred maintenance
Curable, physical deterioration that should be corrected immediately, although work has not commenced.

depreciation:
1) In appraising, a loss in property value from any cause; 2) In regard to improvements, depreciation involves both deterioration and obsolescence.

direct capitalization
A method used to convert an estimate of one year's income into an indication of value in one direct step, either by dividing the income estimate by an appropriate rate or by multiplying the income estimate by an appropriate factor.

discounted cash flow analysis
The procedure in which a discount rate is applied to a set of projected income streams and a reversion. The analyst specifies the timing, amount, variability and duration of the sources of income along with the amount and timing of the reversion and discounts each to its present value at a specified yield rate.

easement.
An interest in real property that conveys use, but not ownership, of a portion of an owner's property.

economic age life method
A method of estimating accrued depreciation in which the ratio between the effective age of a building and its total economic life is applied to the current cost of the improvements to obtain a lump sum deduction.

economic life
The period over which improvements to real property contribute to property value.

effective age.
The age indicated by the condition and utility of a structure.

effective gross income (EGI).
The anticipated income from all operations of the real property after an allowance is made for vacancy and collection losses.

effective gross income multiplier.
The ratio between the sale price (or value) of a property and its effective gross income.

effective interest rate
Interest per dollar per period; the nominal annual interest rate divided by the number of conversion periods per year.

equity
The net value of a property, calculated by subtracting all liens or other charges against the property from its total value.

equity capitalization rate
An income rate that reflects the relationship between a single year's pretax cash flow expectancy and the equity investment.

equity debt ratio.
The ratio of the equity value or equity capital invested in a property to the amount of debt incurred on that property.

equity ratio
The ratio between the down payment paid on a property and its total price; the fraction of the investment that is unencumbered by debt.

equity yield
The dollar return on equity from all sources.

escalation clause.
A clause in an agreement that provides for the adjustment of a price or rent based on some event or index.

estate.
A right or interest in property. excess land. The land not needed to accommodate the site's highest and best use.

excess rent.
The amount by which contract rent exceeds market rent at the time of the appraisal; created by a lease favorable to the landlord.

expense ratio.
The ratio of total expenses, excluding debt service, to either potential or effective gross income.

externalities.
The principle that economics outside a property have a positive effect on its value while diseconomies outside a property have a negative effect upon its value.

external obsolescence.
An element of accrued depreciation; a defect, usually incurable, caused by negative influences outside a site and generally incurable on the part of the owner, landlord, or tenant.

fee simple estate.
Absolute ownership unencumbered by any other interest or estate, subject only to the limitations imposed by the governmental powers of taxation, eminent domain, police power, and escheat.

fixed expenses.
Operating expenses that generally do not vary with occupancy and which prudent management will pay whether the property is occupied or vacant.

functional utility.
The ability of a property or building to be useful and to perform the function for which it is intended according to market tastes and standards; the efficiency of a building's use in terms of architectural style, design and layout, traffic patterns, and the size and type of rooms.

grantee.
A person to whom property is transferred by deed or to whom property rights are granted by a trust instrument or other document.

grantor.
A person who transfers property by deed or grants property rights through a trust instrument or other document.

gross building area
The total floor area of a building, including below grade space but excluding unenclosed areas, measured from the exterior of the walls.

gross income multiplier.
The ratio between sale price or value and potential or effective annual gross income.

gross leaseable area
The total floor area designed for the occupancy and exclusive use of tenants,

gross lease.
A lease in which the landlord receives stipulated rent and is obligated to pay all or most of the property's operating expenses and real estate taxes.

gross rent multiplier
The relationship or ratio between the sale price or value of a property and its gross rental income.

highest and best use.
The reasonably probable and legal use of vacant land or an improved property, which is physically possible, appropriately supported, financially feasible, and that results in the highest value. The four criteria the highest and best use must meet are legal permissibility, physical possibility, financial feasibility, and maximum profitability.

holding period.
The term of ownership of an investment.

incurable functional obsolescence.
An element of accrued depreciation; a defect caused by a deficiency or superadequacy in the structure, materials, or design, which cannot be practically or economically corrected.

incurable physical deterioration.
An element of accrued depreciation; a defect caused by physical deterioration that cannot be practically or economically corrected.

insurable value.
1) The portion of the value of an asset or asset group that is acknowledged or recognized under the provisions of an applicable loss insurance policy. 2) Valued used by insurance companies as the basis for insurance.

interim use.
The temporary use to which a site or improved property is put until it is ready to be put to its future highest and best use.

internal rate of return
The annualized yield rate of return or rate of return on capital that is generated or capable of being generated within an investment or portfolio over a period of ownership.

land to building ratio.
The proportion of land area to gross building area.

land residual technique.
A capitalization technique in which the net operating income attributable to the land is isolated and capitalized to indicate the land's contribution to total property value.

lease.
A written document in which the rights to use and occupy land or structures are transferred by the owner to another for a specified period of time in return for a specified rent.

leased fee estate.
An ownership interest held by a landlord with the rights of use and occupancy conveyed by lease to others.

leasehold estate.
The interest held by the lessee (the tenant or renter) through a lease conveying the rights of use and occupancy for a stated term under certain conditions.

loan to value ratio
The ratio between a mortgage loan and the value of the property pledged as security; usually expressed as a percentage

market rent.
The rental income that a property would most probably command in the open market; indicated by the current rents paid and asked for comparable space as of the date of the appraisal.

mortgage constant
The capitalization rate for debt; the ratio of the annual debt service to the principal amount of the mortgage loan.

net lease.
A lease in which the tenant pays all property operating expenses in addition to the stipulated rent.

net operating income
The actual or anticipated net income that remains after all operating expenses are deducted from effective gross income, but before mortgage debt service and book depreciation are deducted.

nominal interest rate
A stated or contract rate; an interest rate, usually annual, that does not necessarily correspond to the true or effective rate of growth at compound interest.

obsolescence.
One cause of depreciation; an impairment of desirability and usefulness caused by new inventions, changes in design, improved processes for production, or other external factors that make a property less desirable and valuable for a continued use.

occupancy rate.
The relationship or ratio between the income received from the rented units in a property and the income that would be received if all the units were occupied.

operating expense ratio
The ratio of total operating expenses to effective gross income.

operating expenses.
The periodic expenditures necessary to maintain the real property and continued production of the effective gross income, assuming prudent and competent management.

paired data analysis.
A quantitative technique used to identify and measure adjustments to the sale prices or rents of comparable properties; to apply this technique, sales or rental data on nearly identical properties are analyzed to isolate a single characteristic's effect on value or rent.

remaining economic life.
The estimated period during which improvements will continue to contribute to property value.

replacement allowance.
An allowance that provides for the periodic replacement of building components that wear out more rapidly than the building itself and must be replaced during the building's economic life.

replacement cost
The estimated cost to construct, at current prices as of the effective appraisal date, a building with utility equivalent to the building being appraised using modern materials and current standards.

residual techniques.
Procedures used to capitalize the income allocated to an investment component of unknown value after all investment components of known values have been satisfied.

risk factor.
The portion of a given return or rate of return from capital invested in an enterprise that is assumed to cover the risks associated with the particular investment.

sale/leaseback.
A financing arrangement in which real property is sold by its owner/user, who simultaneously leases the property from the buyer for continued use.

supply and demand.
In real estate appraisal context, the principle of supply and demand states that the price of real property varies directly, but not necessarily proportionately, with demand and inversely, but not necessarily proportionately, with supply.

units of comparison.
The components into which a property may be divided for purposes of comparison; e.g., price per square foot, front foot, cubic foot, room, bed, set, apartment unit.

variable expenses
Operating expenses that generally vary with the level of occupancy or the extent of services provided.

yield capitalization.
The capitalization method used to convert future benefits into present value by discounting each future benefit at an appropriate yield rate or by developing an overall rate that explicitly reflects the investment's income pattern, value change, and yield rate.