A Lexicon is the vocabulary of a particular language or profession. The following list of terms defines each term in the way it is most commonly used in the field of real estate and investing.
|Appreciation||Appreciation is the increase in value of a property over time due to inflation, supply and demand, capital improvements and other factors.|
|Capitalization Rate||A rate of return on a real estate investment property based on the expected income that the property will generate. Capitalization rate is used to estimate the investor’s potential return on his or her investment. This is done by dividing the income the property will generate (after fixed and variable costs) by the total value of the property.Capitalization Rate (cap rate) = Yearly income (after expenses) / Total Value|
|Capital Gains||The profit that an owner makes when selling real estate or other property.|
|Cash Flow||The difference (in monetary value) between the total amount spent (expenses) and the total amount received (income) in a given period (e.g., monthly, yearly).|
|Cash on Cash Return||
A rate of return used in real estate transactions. The calculation determines the cash income return on the cash invested. Calculated as:
cash-on-cash return = annual dollar income / Total dollars invested
|Debt Coverage Ratio||Also known as Debt Service Coverage Ratio (DSCR). The debt coverage ratio (DCR) is a widely used benchmark which measures an income producing property’s ability to cover the monthly mortgage payments.|
|Depreciation||Depreciation is the loss in value of an asset / building over time due to wear and tear, physical deterioration and age.|
|Depreciation Recapture||When property is sold at a gain, some element of that gain is attributable to depreciation deductions taken in prior years.|
|Discounted Cash Flows||A valuation method used to estimate the return of an investment opportunity. Discounted cash flow (DCF) analysis uses future free cash flow projections and discounts them (most often using the weighted average cost of capital) to arrive at a present value, which is used to evaluate the potential for investment. If the value arrived at through DCF analysis is higher than the current cost of the investment, the opportunity may be a good one.Calculated as:
|Equity||The value of a property owner’s unencumbered interest in real estate. Equity is the difference between the property’s fair market value and the unpaid principal balance of the mortgage and any liens. Equity increases as the mortgage is paid down and/or as the property appreciates in value.|
|Foreclosures (Bank)||Foreclosure is a legal process that is initiated by the holder of a mortgage or lien when the borrower is in default. The delinquent property is sold at public auction to recover the lenders investment.|
|Foreclosures (Tax)||A tax foreclosure is a legal procedure used by government agencies to enforce a lien against a property for non-payment of income taxes or property taxes. Government agencies hold tax foreclosures one to four times a year. The IRS will sometimes place a tax lien on a home or other real property and sell it at an auction to recover the unpaid income taxes.|
|Gross Rent Multiplier||A rough measure of the value of an investment property that is obtained by dividing the property’s sale price by its gross annual rental income. GRM is used in valuing commercial real estate, such as shopping centers and apartment complexes, but is limited in that it does not consider the cost of factors such as utilities, taxes, insurance, maintenance and vacancies. Other, more detailed methods commonly used to value commercial properties include capitalization rate (cap rate) and the discounted cash flow method.|
|Income Approach||The income approach is used to estimate the market value of income producing properties such as office buildings, warehouses, apartment buildings and shopping centers.|
|Income Tax Bracket||The rate at which an individual is taxed.|
|Internal Rate of Return||
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, a project with a substantially higher IRR than other available options would still provide a much better chance of strong growth.
|Leverage||The use of various financial instruments or borrowed capital, to increase the potential return of an investment. The amount of debt used to finance assets; significantly more debt than equity is considered to be highly leveraged. Leverage is most commonly used in real estate transactions through the use of mortgages to purchase a home.|
|Loan Points||In real estate mortgages, the initial fee charged by the lender, with each point being equal to 1% of the amount of the loan. It can also refer to each percentage difference between a mortgage’s interest rate and the prime interest rate.|
|Loan-To-Value Ratio (LTV)||A lending risk assessment ratio that financial institutions and others lenders examine before approving a mortgage. 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.
Calculated as: Loan to Value Ratio = Mortgage Amount / Appraised Value of the Property
|Modified Internal Rate of Return||While the internal rate of return (IRR) assumes the cash flows from a project are reinvested at the IRR, the modified IRR assumes that postive cash flows are reinvested at the investor’s cost of capital, and the intial outlays are financed at the investor’s financing cost. Therefore, MIRR more accurately reflects the cost and profitability of an investment.
The formula for MIRR is:
|Net Income Multiplier|
|Net Operating Income|
|Operating Expense Ratio|
|Passive Activity Loss|
|PITI||Principal, Interest, Tax, and Insurance|
|Projected Cash Flow|