Glossary

Accelerated Depreciation
Depreciation methods that allow a taxpayer to take faster write-offs than with straight-line during the early part of an asset's useful life .

Accumulated Depreciation
The sum of annual depreciation deductions taken to date .

Adjusted Basis
The original cost of real estate, plus capital improvement s, less accumulated depreciation and costs of sale. The taxable gain at the time of sale is, in general, the selling price less the adjusted basis.

Amortization
The process through which a loan is retired over time through periodic repayment of the principal.

Annual Debt Service (ADS)
The annual total of mortgage payment s including both principle and interest. Also called Debt Service.

Annual Property Operating Data (APOD)
A form that lists a property's gross income, individual operating expense s and net operating income. An APOD is similar to a business profit-and-loss statement.

Appreciation
The increase over time in the value of an asset due to economic factors rather than to improvement s or additions.

Balloon Payment
A provision in a loan that requires the principal balance to be paid off in a lump sum before the loan would be retired through normal amortization. For example, a loan may be written with a fifteen-year amortization and a seven-year balloon . The periodic payment amount and the interest and principal portion of each payment are all calculated as if the loan were to run for fifteen years. However, the borrower would retire the loan at the end of seven years by paying the balance outstanding (the balloon) at that time.

Basis
The starting point for computing gain or loss on an investment; typically, the original purchase price. See also, Adjusted Basis.

Book Value
An asset's original basis less accumulated depreciation.

Capital Gain
Gain from the sale or disposition of a capital asset, such as real estate. May be long term or short term.

Capital Improvement
An addition to a piece of real estate having a useful life of more than one year, or an improvement that is likely to prolong the life of the property. A capital addition is different from a repair, which maintains rather than increases the life of a property.

Capitalization Rate (Cap Rate)
If one were to pay all cash for a building the cap rate illustrates the straight percentage return on an investment. It should be noted that appreciation is not taken into account in calculating a cap rate. A Capitalization Rate, for a given property is obtained by dividing the net operating income by the purchase price.

Cash Flow Before Taxes (CFBT)
Obtained by subtracting Annual Debt Service from the Net Operating Income.

Cash-on-Cash Return
The percentage rate of return on an investment measured as the ratio between the cash flow before taxes and the initial cash investment.

Closing Costs
Costs paid for documentation in connection with the purchase or sale of a piece of real estate. Title insurance is usually considered a closing cost, but real estate commissions , loan fees, prepaid interest and fire or liability insurance are not considered closing costs.

Commercial Property
Residential Income Investments of five or more units. Also see Non-Residential Property.

Commission
A fee paid, typically to a real estate agent or broker, for negotiating a loan, lease, purchase or sale.

Comparables (Comps)
For purposes of valuation, properties that are similar to the subject property and that have been recently sold or leased.

Comprehensive Market Analysis (CMA)
An analysis that produce recommended purchase or selling prices, based on comparables, time on market, differences between asking and selling prices, in addition to other available variables.

Consumer Price Index (CPI)
An index published by the U. S. Bureau of Labor Statistics and widely used as a measure of inflation. The index estimates the cost of buying a fixed group of goods and services and compares that cost to the base year (1982) that was assigned an index value of 100. The CPI is commonly used in escalation clauses of commercial real estate leases so that the rent generated by those leases will keep pace with inflation.

Costs of Sale
Fees typically paid to a broker the sale of a piece of real estate. These fees can often be used to adjust the basis of the property.

Cost Segregation
Cost segregation is accomplished through specialized appraisers, who separate property components depreciable over periods of 5, 7, 15, 27½ and 39 years. The goal of which is to increase annual depreciation deductions for federal income tax purposes.

Debt Coverage Ratio (DCR)
The ratio between the net operating income and the annual debt service (NOI ÷ ADS) Most lenders require a debt coverage ratio of at least 1.2 which means that the property generates 20 percent more net income than it needs to make its mortgage payments.

Debt Service
See Annual Debt Service .

Depreciation
Appraisers usually refer to “depreciation ” as the actual loss in value due to physical wear and tear along with functional and economic obsolescence. (See Depreciation Allowance)

Depreciation Allowance
The amount of the tax deduction that a property owner may take each year until he or she has written off the entire depreciable asset. In real estate, the physical structures are considered depreciable assets, but the land is not.

Discount Rate
The compound interest rate used to reduce expected future cash flow s to their estimated present value.

Effective Gross Income (EGI)
See Gross Operating Income.

Escalation
A clause in a real estate lease that provides for an adjustment to the rent, usually based on some external event, such as a rise in the Consumer Price Index ( CPI ).

Equity
The difference between a property's current value and the total debt against it. A property worth $1,000,000 with loans totaling $750,000 has equity of $250,000.

Expense Stop
A provision in a lease where the tenant agrees to pay the excess of certain operating expense s over a base amount. The landlord pays the expense up to the amount of the expense stop and the tenant pays or reimburses the landlord for the rest.

Fair Market Value
The price at which a property would change hands from a willing seller to a willing buyer, where neither party is under a compulsion to sell or buy and where both have reasonable knowledge of all pertinent facts. Also, Market Value.

First Mortgage
The first, or senior claim against a property, as security for repayment of a debt.

Funded Reserves
A sum of money put aside so that it will be available to handle an extraordinary expense or improvement . For example, an investor may anticipate the need for a new roof five years after acquisition of a property and place money into a reserve account in advance so that funds are available when needed.

Gross Operating Income (GOI) - A property's Gross Scheduled Income minus an allowance for anticipated vacancies.

Gross Rent Multiplier (GRM)
A method of estimating or expressing a property's value as a multiple of its gross rental income. For the evaluation of properties a GRM is not as reliable as the Capitalization Rate.

Gross Scheduled Income
The annual income of a property if all rentable space were in fact rented and all rent collected; the total potential income.

Half-Month Convention
A provision of the tax code as of this writing that allows only one-half month of depreciation in the month a property is acquired and one-half month in the month it is sold.

Improvement
See Capital Improvement

Income Property - Real property leased to tenants and held for the purpose of generating rental income.

Initial Investment
The amount of cash invested at the time a property is purchased.

Interest-Only Mortgage
A mortgage loan in which the borrower makes periodic payment s of interest only and pays the full principal balance at the end of the loan term .

Internal Rate of Return (IRR)
Technically, IRR is a discount rate: the rate at which the present value of a series of investments is equal to the present value of the returns on those investments.

Lease
A contract granting possession of land or a specified part of a building for a specified time in exchange for rent.

Lessor
An owner who leases property to a tenant; landlord.

Lessee
A tenant who leases property from a landlord.

Market Value
See Fair Market Value.

Modified Internal Rate of Return (MIRR)
An alternative to conventional Internal Rate of Return (IRR). IRR will usually will fail to yield a result in a situation where there are negative cash flow s. The MIRR calculation takes any negative cash flows (after utilization of reserves), zeroes them out and discount s them at a safe rate back to day one of the investment period. The discounted amount is treated as additional capital needed on day one. MIRR also takes positive cash flows and compounds them forward to the sale year, using the reinvestment rate (also known as the risk rate).

Mortgage
A lien against a property that secures a mortgage loan or note.

Mortgagee
The lender in a mortgage agreement.

Mortgagor
The borrower in a mortgage agreement.

Net Operating Income ( NOI )
A property's Gross Operating Income less the sum of all operating expense s excluding property taxes and debt service.

Operating Expenses
Those expenses incurred in the maintenance of a piece of real property including categories such as utilities, repairs gardeners and so forth. Debt service, depreciation, and capital improvements are not included in the Operating Expenses.

Pass Through
An operating expense that is passed on, in whole or in part, to a tenant. For example, a lease may require that a particular tenant pay a pro-rata share of property taxes in excess of $10,000. If the tax bill is $50,000, and the tenant occupies 5 percent of the property's rentable area, then the tenant must pay 5 percent of $40,000 (the amount of the tax bill over $10,000), or $2,000. The landlord treats this as an income item; often call a “recoverable expense.”

Personal Property
Property that is movable, not permanently attached to the real estate. Appliances are personal property .

Point(s)
A fee paid to a lender for the lender's service in making the loan. Typically a point is equal to one percent of the amount of the loan. Points are not deductible as an expense, but must be written off over the life of the loan.

Principal
The total amount of a loan, not including interest.

Private Annuity Trust
Definition to come

Pro Forma
Latin for "as a matter of form” is used on balance sheets and income statements to refer to data that is hypothetical. Often displayed on property listings to provide, based on multiple assumptions, an idea of possible future performance of an income property.

Recoverable Expense
See Pass Through.

Reinvestment Rate
In Modified Internal Rate of Retur n , the rate at which you believe you could reinvest the positive cash flow s from your investment. Also known as the Risk Rate.

Rentable Square Feet
The portion of a rental property that may be leased to tenants. For example, in a multi-tenant office building the office suites themselves contain rentable space, but hallways and stairways outside those suites typically are not included as part of the rentable area.

Resale
See Reversion

Residential Property
Real estate designed and intended as dwellings, including single- and multi-family homes, but not hotels or motels. A property that combines both residential and non-residential uses must derive at least 80 percent of its gross rental income from dwelling units to be considered residential for purposes of depreciation . If a mixed-use property is owner-occupied, then the fair-market rental value of the owner's unit must be taken into account when determ ining the residential or non-residential status of the property.

Reversion
The value of an investment at the time of its resale.

Risk Rate
See Reinvestment Rate

Safe Rate
In Modified Internal Rate of Retur n , the interest rate at which you believe you can put the money aside, in a secure and reasonably liquid form, so that it will grow to meet the amount needed to cover future negative cash flow s.

Sensitivity Analysis
An analysis in which one or more independent variables is altered to determ ine the effects on a specific dependent variable. For example, one might test how different rental rate s alter the cash flow before taxes.

Straight-Line Depreciation
A depreciation method that allows the owner to write off an asset's basis in equal amounts over its useful life . For example, if an asset were to have a 10-year useful life, the straight-line depreciation allowance each year would be 10 percent of the basis. Note that in the tax code as of this writing there is a half-month convention for real estate, where the taxpayer is allowed only one-half month depreciation in the month of acquisition and one-half month in the month of resale .

Tax-Deferred Exchange (1031 Exchange)
The IRS Code (sec. 1031) allows owners of Real and Personal property to sell their property and purchase other like kind property while deferring capital gains tax as long as certain criteria are met.

Tenant Improvements (TI)
Improvements made to a rental unit by a landlord for the benefit of a tenant. The costs of such improvement s are classified as capital expenditures, not repairs.

Useful Life
The length of time, as specified in the tax code, over which an asset may be depreciated. The Useful Life for tax purposes may not be synonymous with the actual useful life of personal or real property.

Vacancy and Collection Allowance
A deduction from the Gross Scheduled Income for losses due to unoccupied space and uncollected rent.