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CRE Terms & Definitions

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CRE Terms & Definitions Abacus Commercial Mortgage Commercial Real Estate Mortgage Terms CRE: Commercial Real Estate Adjustable Rate Mortgage (ARM): When you take out a mortgage, you can either select a fixed rate or an adjustable rate mortgage. With an ARM, the interest rate can change over the duration of your loan. So, this type of loan is often viewed as risky if you plan to keep a property in your portfolio for more than a few years. With a fixed- rate mortgage, the interest rate stays the same throughout the lifetime of the loan. ARV: After Repair Value: the estimation of what a property will be worth once all repairs, updates, and add- ons are done. Amortization: The schedule under which loan principal is to be repaid. Each payment is typically split between principal and interest. The amortization schedule will show how much principle vs. interest is applied with each payment. Commercial loans generally amortize over a 10- to 30-year period. Annual debt service: The total sum paid each year on a commercial real estate loan. ADS include principal and interest, with the amount of each paid defined by the amortization schedule. Balloon payment: The amount of principal due to the lender upon loan maturity if a loan is not fully amortized. For example, a 10-year loan with a 30-year amortization will have a balloon payment due at the end of the 10-year period equivalent to the principle remaining owed on the loan. Basis point: Equivalent to 1/100 of one percent. In commercial real estate, it is used to describe the interest rate on a loan. If someone is paying 325 basis points, for example, they are paying 3.25% interest on the loan. Sometimes basis points are referred to by people in the industry as “bips”. Bridge loan: A short-term loan used to allow a borrower time and/or temporary financing until they can obtain permanent financing. Bridge loans typically range from 6 months to 3 years in length. They are sometimes used while a borrower is renovating a property or looking to find a long-term commercial tenant. For more on specific loan types, read here. Cap rate: The cap rate, formally the “capitalization rate,” is one method of valuing a property’s income generating potential. A cap rate is expressed as a percentage and is calculated by dividing the property’s net operating income by the purchase price. Capital gain: The taxable income derived from the sale of an investment property. It is equivalent to the sales price less the cost of the sale, adjusted basis, suspended losses, excess cost recovery, and recapture of straight-line cost recovery. Common Area Maintenance: Common Area Maintenance (CAM) is a figure that tells landlords the expenses they are responsible for paying to maintain a property. Contingency reserve: An additional set of funds set aside, typically during a construction or renovation project, that can be used in the event of cost overruns. Collar: A phrase that is used to define the upper and lower limits established on an adjustable rate mortgage. More often, the terms “floor” and “cap” are used to describe these limits. Cost basis: The total cost of a property, including hard and soft costs, less any depreciation. Upon sale, the amount a person pays in capital gains is equivalent to the sales price less their cost basis. Defeasance: A method for reducing the fees required when a borrower decides to prepay a fixed-rate CRE loan. Instead of paying cash to the lender, the defeasance option allows the borrower to exchange another cash flowing asset for the original collateral for the loan. Discount rate: The percentage rate at which money or cash flow are discounted. The discount rate accounts for both a market risk-free rate of interest and risk premium. DSCR: The debt service coverage ratio is the relationship between a property’s annual NOI (Net Operating Income) and its annual mortgage debt service. For example, a property with a $500,000 NOI and $400,000 in annual debt service has a 1.25 DSCR. A measure of the cash-flow available to pay current debt obligations. Used to analyze projects and borrowers. Lender ratios are predicated on the state of economy and can be adjusted at their discretion. Exit fee: An exit fee is a one-time payoff due to the lender when paying off a loan in full, either prepaying the loan or at maturity. It is like paying points, except this allows a lender to offer a lower interest rate and does not require a borrower to make an upfront payment like they would if paying points on a loan. Fannie Mae (FNMA) and Freddie Mac (FHLMC): This pair may sound quite odd, but they are important commercial real estate terms. The Federal National Mortgage Association (FNMA) also goes by the nickname of Fannie Mae. The Federal Home Loan Mortgage Corporation (FHLMC) is known as Freddie Mac. The purpose of both entities is to create a secondary market for the sale and purchase of mortgages. In fact, Fannie Mae and Freddie Mac are the largest purchases of mortgages on the secondary market and are both government-sponsored enterprises created by Congress. Fixed Costs and Variable Costs: Fixed costs do not change when the number of outputs changes. So, a fixed cost is never zero, even if your production rate is zero. For example, your insurance premiums, rent or loan value is a fixed cost. As such, fixed costs can create economies of scale. Variable costs change with the amount of output. In other words, they rise when production expands and fall when it contracts. Examples include packaging, raw materials, and labor. Gross rent multiplier: A method used to evaluate a property’s market value. This method calculates the market value of a property by using projected annual gross rents multiplied by a given factor (known as the gross rent multiplier within a given market). Hard costs: The costs associated with the physical aspects of a real estate deal, such as construction costs, materials, and labor. Cement, drywall, carpet, and landscaping are examples of hard construction costs. High-Ratio Loan: These typically have higher interest rates compared to other loans because they are deemed riskier. For example, if the borrower defaults on a high-ratio loan, the property may not raise enough capital when sold for the bank to repay the loan. As a result, the borrower may need to take out mortgage insurance to balance this risk. Interest Only Mortgage: You only pay the interest on the mortgage loan for a set period. This interest rate may be fixed or variable. LIBOR: A benchmark interest rate that banks offer to lend funds to one another on the international banking market. It stands for the London Interbank Offered Rate and helps the various bodies calculate interest rates on loans around the world. Lender: The person or entity (such as a bank) that is loaning money on a commercial real estate deal. Leverage: The process of utilizing debt in real estate financing. The terms “debt” and “leverage” are often used interchangeably by commercial real estate professionals. Lenders prefer individuals to employ LIBOR: Stands for London Interbank Offered Rate. This is the interest rate at which banks offer to lend funds (wholesale) to one another in the international banking market. Most banks tend to lend money to individual borrowers at a rate of “LIBOR plus X basis points”. Loan-to-Cost Ratio: A metric used in commercial real estate construction to compare the financing of a project as offered by a loan to the cost of building the project. The LTC ratio helps lenders assess the risk associated with a project before offering a construction loan on the project. Loan-to-Value Ratio: Often referred to as “LTV,” this is the amount of money borrowed in relation to the total market value of a property. LTV is calculated by dividing the loan amount by the property value. Maturity Date: The date upon which a loan is due. Mezzanine Loan: A “middle” layer of debt in a commercial real estate capital stack. Mezzanine debt falls between secured senior debt and equity and is usually not secured by the actual asset. Mezzanine debt is issued solely based on a borrower’s ability to make debt service payments from free cash flow. Net Operating Income: The potential rental income plus other income, less vacancy, credit losses and operating expenses. Open-Ended Construction Loan: A type of commercial mortgage that allows the borrower to borrow additional money on the same loan up to a certain limit. The benefit of taking out an open-ended construction loan is that it saves the borrower the effort of obtaining a separate construction loan. Operating Expenses: Often referred to as “OpEx”, this refers to the cash outlay necessary to operate and maintain a property. Operating expenses could include real estate taxes, property insurance, property management expenses, utilities and legal or accounting expenses. Origination Date: The date a new loan takes effect. This is the opposite of the maturity date. Portfolio Loan: A loan that a lender intends to keep on its books, or part of its “portfolio,” instead of selling off. As a result, the loan is not subject to the same stringent underwriting requirements that would otherwise be necessary. Rent Roll: A register of rents that includes the names of tenants and amounts due, including any back-owed rents. A lender will typically ask a borrower to furnish a copy of the rent roll as proof of the property’s cash flow.
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