As Spencer and I continue to flesh out the Adventures in CRE Glossary of Commercial Real Estate Terms, we thought it would be fun and useful to provide some of our readers who are just starting out in the industry with some practice flashcards. We hope you can use this as a tool to test yourself with common and not-so-common CRE terminology. Every month or so, we will continue to put out a new deck of terms from our glossary. This series of flashcards may prove useful throughout your early career and particularly during the interview process.
We hope that these are helpful.
CRE Flashcards
Deck #4 – Commonly Used CRE Metrics – September 2019
IRR (INTERNAL RATE OF RETURN)
Answer:
The discount rate at which the net present value of an investment is equal to zero. The internal rate of return is a time value of money metric, representing the true annual rate of earnings on an investment. In real estate practice, IRR is used together with other return metrics such as equity multiple, cash-on-cash return, and average rate of return to compare real estate investments and make investment decisions.
CAP RATE
Answer:
The Cap Rate, or Capitalization Rate, is the percentage derived from a stabilized asset’s annual NOI divided by its purchase price.
Investors often look to cap rates that have been set in the market to begin getting a ball park idea of what they might pay for an asset they are looking to invest in. For example, an investor is looking at a Class A office asset in X market. Class A office buildings in X market have been trading between a 5% – 6% cap rate over the past 6 months, so an investor may look to his or her first year of projected NOI and divide that by a cap rate of somewhere between 5% – 6% to get an idea of the price he or she might need to pay.
FREE AND CLEAR RETURN
Answer:
The total unlevered (before debt) pre-tax cash flow of a real estate project divided by the total capital invested, generally expressed as a percentage on an annual basis. While the Free and Clear Return does not account for taxes and does not take into account the time value of money, it is a useful screening tool used by investors when evaluating potential investments. The Free and Clear Return is the unlevered equivalent of the Cash-on-Cash Return, and thus sometimes referred to as the Unlevered Cash-on-Cash Return.
EQUITY MULTIPLE
Answer:
A return metric which shows how much an investor’s capital has grown over time. The equity multiple (EMx) is calculated by dividing the sum of all capital inflows (capital distributions) by the sum of all capital outflows (capital contributions). While the equity multiple does not account for the time value of money, it does describe the total cash returned to the investor and is thus often utilized alongside the internal rate of return in real estate investment analysis.
DISCOUNT RATE
Answer:
The rate at which future cash flows are discounted and then added together to create a present value in a discounted cash flow (DCF) model. In real estate valuation models, the discount rate can be interpreted as the Cap Rate plus expected NOI growth, representing the income and growth components of total required rate of return respectively.
DEVELOPMENT YIELD
Answer:
A metric used in real estate development, Development Yield is calculated as the project’s net operating income (or sometimes cash flow from operations) at stabilization divided by the total project cost. Development Yield is also referred to as a project’s Yield-on-Cost.
DEVELOPMENT SPREAD
Answer:
The difference, denoted in basis points, between the market cap rate and the yield-on-cost . The Development Spread measures the “development pop”, or value-added by taking on the construction and lease-up risk. The greater the development spread, the more likely a development project will be deemed financially feasible.
DEBT YIELD
Answer:
The ratio of Net Operating Income (NOI) to the mortgage loan amount, expressed as a percentage. The debt yield is useful to lenders as it represents the lender’s return on cost were it to take ownership of the property. Among other metrics, lenders use debt yield to determine an appropriate loan amount.
DEBT SERVICE COVERAGE RATIO
Answer:
A financial metric used in real estate to measure a property’s ability to cover its debt obligations. The Debt Service Coverage Ratio (DSCR or DSC) is calculated by dividing the net operating income by the debt service payment and is often expressed as a multiple (i.e. a DSCR of 1.20x). The DSCR is used by banks to determine the maximum loan amount offered to a borrower and to assess the probability that a borrower might default on the loan.
CASH-ON-CASH RETURN
Answer:
Before tax cash flow (BTCF = CFO – Debt Service) divided by the total equity contribution to date, expressed on an annual basis as a percentage. While the Cash-on-Cash Return (CoC) does not account for taxes and does not take into account the time value of money, it is a useful screening tool used by investors when evaluating potential investments.
Deck #3 – Hotel Specific Vocab – August 2019
Total RevPAR
Answer:
Where RevPAR divides total revenue from room sales by available rooms in a given period, Total Revenue Per Available Room (TRevPAR or Total RevPAR) is a metric that includes total revenue from all hotel departments in addition to room revenue. Other departments are typically and formally categorized as F&B, Other Operated Departments, and Miscellaneous Income.
ADR
OS&E
Answer:
OS&E is a common initialism used in the hotel industry for Operating Supplies and Equipment. OS&E refers to an enormous range of items that a hotel will need to operate. OS&E does not include items like stoves or washing machines or any major items that require installation. Examples of OS&E are as follows:
- Dishware
- Cutlery
- Trashcans
- Trays
- Cleaning supplies
- Staff uniforms
- Office supplies
- Irons and ironing boards
- Luggage carts
- Vacuums
Limited Service Hotel
Answer:
A hotel that provides only the basic amenities and services with some hotels offering facilities such as a swimming pool and/or business center. Limited service hotels (such as Fairfield Inn or Homewood Suites) operate on smaller budgets enabling them to pass on the cost savings to travelers via lower room rates.
Key Money
Answer:
Money provided by a hotel operator or hotel “flag” to a hotel owner in order to secure a hotel management or franchise agreement at a hotel property. In highly competitive hotel markets, where operators are looking to get a foothold or expand their brand, operators may use key money as one negotiating tool and will compensate the hotel owner as part of the agreement.
Key money is especially relevant in hotel development projects where risks are particularly high and lenders may be much more conservative for this risky asset class.
Hotel “Flag”
Answer:
An informal term used to denote an operating brand within the hotel industry. Marriott, Hilton, and Best Western are examples of “Flags” used by owners of hotel properties.
Full Service Hotel
Answer:
A hotel that has a dedicated F&B component and offers a full range of amenities and services such as concierge service, bars and restaurants, pool and spa, etc. Full service hotels have high fixed costs and appeal to the more affluent casual and business travelers who are able to afford the higher than average room rate.
FF&E
Answer:
Furniture, Fixtures, and Equipment (FF&E). In real estate financial analysis, FF&E is most often found as a line item in development budgets and operating statements. It can generally be defined as any easily moveable object not permanently affixed to the building. Examples of FF&E are as follows:
- Chairs
- Beds
- Couches
- Curtains
- Desks
- Sconces
- Tables
RevPAR
Answer:
Revenue Per Available Room
RevPar = Total Actual Revenue in Given Period ÷ Available Rooms
Or
RevPar = ADR x Occupancy Rate
Deck #2 – June 2018
EQUITY MULTIPLE
Answer:
A return metric which shows how much an investor’s capital has grown over time. The equity multiple (EMx) is calculated by dividing the sum of all capital inflows (capital distributions) by the sum of all capital outflows (capital contributions). While the equity multiple does not account for the time value of money, it does describe the total cash returned to the investor and is thus often utilized alongside the internal rate of return in real estate investment analysis.
RENT ROLL
Answer:
A list of tenants in an income producing real estate asset and the property owners’ reflection of all the rental income derived from the tenants at a specific time (usually at the end of the month). The rent roll often includes other information related to the tenants, such as a description of the space being rented, lease start/expiry dates and any security deposits held.
CONCESSIONS
Answer:
Also referred to as an “Inducement”, any preferential financial treatment offered by one party to another in a real estate transaction. In the case of a lease agreement, a concession most often takes the form of free rent for a period of time or an agreement by the landlord to waive certain charges such as parking charges or pet fees. These concessions are meant to induce the tenant to sign the lease. Concessions are most often used during initial lease-up (i.e. when a building first delivers) or during tenant-friendly periods in the market cycle to maintain rent rates.
CAPITAL EXPENDITURE (CAP EX)
Answer:
An expense used to upgrade a property which is expected to result in a long-term (longer than 1 year) improvement. Typical capital expenditures (CapEx) include roof repairs, HVAC replacement and other expenses generally related to the structural improvement of the building. For tax purposes, Capital Expenditures are capitalized and depreciated over a period of years with the length of the depreciable life varying depending on the capital item.
OPTION
Answer:
An Option or Option Agreement is a formal agreement between a property owner and a potential buyer or lessee, in which the potential buyer or lessee usually pays the owner for the exclusive right to a negotiation in good faith over a certain time period for the purchase or lease of the property.
OPPORTUNISTIC (INVESTMENT STRATEGY)
Answer:
A real estate investment strategy categorized by high risk and high returns. Opportunistic real estate strategies typically involve a high degree of uncertainty, more volatility in cash flow and require greater subject matter expertise. These strategies will often employ more leverage and subject the investors to a greater probability of losing their capital. Opportunistic real estate investments are most often either ground-up developments or the redevelopment of properties to a higher and better use.
CORE PLUS
Answer:
Core Plus assets are properties that are otherwise Core assets, but with some component of risk (opportunity) attached to it. It may be a high street retail building with a tenant that takes 10% – 15% of the space vacating in 2 years and the space needs to be upgraded and re-leased. Or it could be an otherwise Core office tower located a bit outside of the prime office submarket with a lease or two that is a bit below market. A levered IRR for this risk profile could be between ~8% to ~13%.
CORE
Answer:
Core – (investment strategy)
A real estate investment strategy categorized by low risk and commensurately low, stable returns. Coreinvestment strategies typically involve longer hold periods, lower levels of leverage, and higher quality assets. Core investments are generally stabilized properties, with high occupancy rates and predictable cash flows. Investors of core real estate investments value stable, reliable and consistent cash flows over price appreciation.
Core – (structural)
The space in a multi-story building that commonly houses the elevators, stairwells, space for vertical MEP distribution, janitorial closets, and restrooms. It is common for buildings to have the core space in the center of the building, but the design and development team may sometimes elect to create a side core for various reasons such as if a central core would create inefficient floor plates that would not compete with the market.
https://www.adventuresincre.com/glossary/core/
NET EFFECTIVE RENT
Answer:
The gross amount of rent payable by a tenant less any costs incurred by the landlord in order to lease the space to the tenant. Such costs typically include leasing commissions, tenant improvements and/or rent-free periods.
VALUE ADD
Answer:
A real estate investment strategy categorized by medium-risk and medium returns. A Value-Add Strategy typically involves acquiring under-performing assets with upside potential and adding value through one or more repositioning strategies. These strategies may include property renovation, tenant realignment, operational improvements and re-tenanting strategies among others with the goal of boosting net operating income, and thus increasing the value of the property.
Deck #1 – May 2018
LOAD FACTOR
Answer:
Rentable area / usable area = load factor
Example: If a building has 50,000 sf of rentable area and 40,000 sf of usable area, the building has a load factor of 1.25 (50,000/40,000)
INTERNAL RATE OF RETURN (“IRR”)
Answer:
The discount rate at which the net present value of an investment is equal to zero. The internal rate of return is a time value of money metric, representing the true annual rate of earnings on an investment. In real estate practice, IRR is used together with other return metrics such as equity multiple, cash-on-cash return, and average rate of return to compare real estate investments and make investment decisions.
Unlevered IRR or unleveraged IRR is the internal rate of return of a string of cash flows without financing.
Levered IRR or leveraged IRR is the internal rate of return of a string of cash flows with financing included.
The Internal Rate of Return is arrived at by using the same formula used to calculate net present value (NPV), but by setting net present value to zero and solving for discount rate r. In Excel, IRR can be calculated by using the IRR(), XIRR(), or MIRR functions.
INTEREST RESERVE
Answer:
A reserve account held by the lender of a construction loan and used by the borrower to cover loan interest shortfalls during construction and lease-up. The interest reserve is funded via the initial proceeds from the construction loan, and is calculated based either on expected future draws or by means of a simple average estimate of the outstanding loan balance throughout the loan period.
ACRE
FLOOR AREA RATIO (FAR)
Answer:
A ratio expressing the relationship between a building’s floor area (currently built or permitted) and the land on which the property is located. A higher FAR ratio indicates a higher density (i.e. the more square feet legally permissible to be built on the land). For example, if a plot of land is 10,000 SF and there is a FAR of 6. The allowable buildable square footage is 60,000 (10,000 x 6).
MEZZANINE DEBT
Answer:
In real estate, mezzanine debt or mezz, is a subordinate loan on real property secured by an interest in the entity that owns the real property rather than on the real property itself. In the event of default, because the entity rather than the real estate acts as collateral, the mezzanine lender is able to foreclose on the entity via a UCC foreclosure – a faster and less expensive process than a foreclosure on the real estate would be. In the capital stack, mezzanine debt falls between mortgage debt and equity. It carries a higher interest rate than more senior debt due to its riskier place in the capital stack.
DEBT COVENANTS
Answer:
Debt covenants are essentially rules written into the loan documents which govern the behaviour of a borrower once the debt is issued. There are 2 general types of covenants which either permit (affirmative covenant) or restrict (negative covenant) the borrower’s ability to perform certain actions. Should the borrower break a covenant, the lender typically has the legal right to call back the loan (i.e. demand repayment).
SPRINGING RECOURSE
Answer:
A form of loan guarantee only enforceable by a lender when certain default or credit events occur (e.g. if a borrower violates operating covenants, does not meet net worth requirements, files for voluntary bankruptcy, etc.). In springing recourse or springing liability, when such adverse events occur, the borrower’s guarantor (i.e. principal) becomes partially or fully liable for the loan obligation regardless of whether the loan is non-recourse or not.
SPONSOR
Answer:
The partner that “sponsors” a real estate investment, this individual or company is responsible for finding, acquiring and managing the investment. The sponsor generally brings market and property type expertise and plays the primary management role, whilst third party investors (limited partners) typically take on a more passive investment role. The Sponsor is also referred to as the General Partner (GP).
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RATIO UTILITY BILLING SYSTEM (RUBS)
Answer:
A method of calculating a resident’s utility bill based on specific factors such as occupancy rate or apartment square footage and then billing the tenant for their share of utility use. It is often used when the installation of sub meters is not financially feasible (due to the large up front capital investment) or economically feasible (due to a poorly designed utility configuration). The practice is becoming increasingly common as landlords seek ways to increase revenue and limit their cost inflation risk.
