Whether you already own a self-storage project or plan to make your first venture, knowing some key terminology is important to your success. You probably won’t find these definitions in a dictionary, yet they can be critical to effective communication and decision-making. Understanding the lingo will help you stay informed and get the most out of your investments. Here are 50 common real estate terms with which you should be familiar:
Abatement:Often referred to as “free rent” or “early occupancy”; may occur outside or in addition to the primary term of the lease.
Absorption Rate:The rate at which rentable space is filled. Gross absorption is a measure of total square feet leased over a specified period with no consideration of the space vacated during that same time. Net absorption is the amount of space occupied at the end of a period minus the amount occupied at the beginning, also considering space vacated.
Ad Valorem:A Latin phrase meaning “according to value.” This is a tax imposed on the value of a property, typically based on the local government’s valuation of the asset.
Amortization Period:The length of time over which the principal portion of a mortgage loan is scheduled to be paid through periodic payments. The “term” of the loan is the length of time before payoff is due.
Assumption:Conveying property, with the buyer assuming liability for paying an existing mortgage loan.
Capital Expenditures:Expenditures that arrest deterioration of a property or add new improvements and appreciably prolong its life, as distinguished from expense items, which are considered part of normal operations.
Capital Gain:The profit on the sale of a capital asset such as real property, calculated as the sales price minus deductible sales expenses and the book value of the asset.
Capitalization Rate (Cap Rate):The ratio of the first year’s net operating income (NOI) to the asking price, or the rate at which NOI is discounted to determine the value of a property.
Cash Flow:The revenue remaining after all cash expenses are paid.
Cash-on-Cash Yield:The relationship, expressed as a percentage, between the net cash flow of a property and the average amount of invested capital during an operating year.
Certificate of Occupancy:A document presented by a local government agency or building department certifying that a building or the leased area has been satisfactorily inspected and is in a condition suitable for occupancy.
Class-A Properties:Properties featuring above-average design and construction quality. They generally command the highest rental rates and have a superior location in terms of desirability or accessibility.
Class B Properties:Properties with adequate design and construction quality (which may not be reflective of current standards and preferences). These typically command average rental rates and are generally well-maintained and desirable to most tenants.
Class C Properties:These properties offer adequate functionality but few amenities. Their physical condition is acceptable but may have some deferred maintenance. They generally command below-average rental rates and are usually in less desirable locations.
Climate Control:Temperature control (with HVAC).
CMBS (Commercial Mortgage-Backed Securities):Securities in the form of bonds or other financial obligations that are backed by a pool of mortgage loans on commercial real estate.
Comparables:A tool used to determine a property’s fair market lease rate or asking price, based on other properties with similar characteristics.
Concessions:What landlords offer tenants to induce them to lease space, most commonly cash or the equivalent in the form of rental abatement (free rent).
Conduit Loan:A loan usually made by a securities firm that sells bonds to investors to raise money for the purpose of lending. The “conduit” is a financial intermediary that makes or purchases loans from originating lenders under standardized terms, underwriting and documents. When sufficient volume has been obtained, the conduit pools the loans for sale to investors in the CMBS market.
Debt Service Coverage Ratio (DSCR):The annual net-operating income from a property divided by the annual cost of debt service. A DSCR of 1 means the property is generating cash flow equal to the debt payments. Most lenders prefer to see a DSCR of 1.25 or better.
Defeasance:A provision in a commercial mortgage loan that allows the borrower to prepay the loan by purchasing U.S. Treasuries. In defeasance, the lender replaces the cash flow of the original loan with treasury securities paid for by the borrower; the property is released as collateral with the treasuries becoming the new loan collateral.
Due Diligence:Activities carried out by a prospective purchaser or mortgager of real property to confirm the asset is accurately represented by the seller and not subject to environmental or other problems.
EBITDA:Earnings before interest, taxes, depreciation and amortization.
Effective Gross Income:The potential gross income less a vacancy factor and a collection loss amount.
Gross Building Area:The total building area, generally including all rental area plus any common areas such as the management office and apartment.
HVAC:Heating, ventilation and air-conditioning.
Ingress/Egress:Relates to the capacity and convenience of the entrances and exits of a property to vehicular traffic.
Institutional-Grade Property:Properties generally owned or financed by tax-exempt institutional investors such as REITs and pension funds.
Internal Rate of Return (IRR):A discounted cash-flow analysis used to determine the potential return of a real estate asset during an anticipated holding period. Put simply, it is the average annual yield on an investment, taking into account projected cash flow (usually after taxes) during the holding period and projected sale proceeds at the end. The sum of the cash flow and sale proceeds is divided by the initial investment (down payment) to calculate IRR.
Leverage:The use of credit to finance a portion of the costs of to purchase or develope a real estate investment. Positive leverage occurs when the interest rate is lower than the cap rate or projected IRR. Negative leverage occurs when the current return on equity is diminished by the employment of debt.
LIBOR (London InterBank Offered Rate):A common loan-pricing index similar to the prime rate; the interest rate that international banks charge each other for large loans.
Loan-to-Value Ratio (LTV):The ratio of the loan principal divided by the property’s appraised value.
Management Fee:The amount charged by an independent company for the day-to-day management of a property, typically based on a percentage of the property’s income.
Market Value:The highest price a property would command in a competitive and open market under all conditions required for a fair sale.
Net Leasable Area:The portion of the building designed to be occupied by tenants and upon which rental payments are based, also called “rentable square feet.”
Net Operating Income (NOI):Total income less operating expenses, before mortgage payments and income taxes.
Nonrecourse Debt:A loan that, in the event of a default by the borrower, limits the lender’s remedies to a foreclosure of the property that collateralizes the loan.
Occupancy:The percentage of space actually occupied by tenants. There are generally three ways to measure this:
- Unit occupancy is the number of occupied units divided by total units.
- Physical occupancy is occupied square feet divided by gross leasable area.
- Economic occupancy is actual income divided by potential gross income.
Operating Expenses:The actual costs associated with operating a property, including maintenance, repairs, management, utilities, salaries, advertising, property taxes and insurance but excluding debt service, depreciation, amortization, capital expenditures and income taxes.
Phase I:An Environmental Site Assessment (ESA) report prepared by a professional consultant that reviews the property—land and improvements—to ascertain the presence or potential presence of environmental hazards. This typically involves the review of previous uses of the subject property and others in the immediate vicinity, a site inspection, and a report on findings by a qualified engineering/ environmental firm. This report includes recommendations for further testing (a Phase II), if deemed necessary.
Phase II:May be required if the Phase I uncovers potential environmental problems. Procedures typically included at this stage are subsurface-soil and water-sample tests and testing of any building materials suspected to be environmental hazards. This report confirms or disavows the presence of an environmental hazard and, should one be found, recommends additional review or mitigation efforts.
Prepayment Penalty:A fee charged by the lender to allow the borrower to retire the loan earlier than its stated maturity.
Recourse Debt:A loan in which the borrower is fully at risk (personal guarantee) to the lender for repayment of the obligation.
Rehab:Extensive renovation intended to cure obsolescence of a building or project.
REIT (Real Estate Investment Trust):A business trust or corporation that combines the capital of many investors to acquire or provide financing for real estate. A corporation or trust that qualifies for REIT status generally does not pay corporate income tax to the IRS. Instead, it pays out at least 90 percent of its taxable income in the form of dividends, thus allowing its investors to avoid double taxation.
Replacement Reserves:An amount set aside to pay for the eventual wear of short-lived assets such as HVAC equipment, asphalt, carpeting, roofing, etc.
Replacement Cost:The estimated current cost to construct a building with utility equivalent to the building being appraised, using modern materials and current standards, design and layout.
Stabilization:When the income generated from a property is stable, consistent and reliable.
Trailing 12:Income and expenses realized during the past 12 months, often used to determine net cash flow for self-storage properties.
Vacancy and Collection Loss:An amount or percentage reflecting income loss (from potential gross income) due to vacancy and non-payment of rent by tenants.
Value-Added:A phrase generally used by advisers and managers to describe investments in under performing or under managed assets.
Zoning:The creation of districts by local governments in which specific types of property uses are authorized.
How much of this terminology did you already know? If the answer is all of it, then congratulations, you’re probably a genius. But don’t worry if that’s not the case. Even so-called experts misunderstand many of the meanings. The good news is, having armed yourself with the knowledge of these terms, you’ll be a smarter investor. Your communications will be more precise, and you’ll be in a better position to make sound business decisions.
Mark Keys is the principal of Cornerstone Realty, a firm that provides brokerage and consulting services to self-storage owners and investors. His industry experience spans more than 20 years. He can be reached at 210.366.8817; e-mail firstname.lastname@example.org.