Patch Terminology

Real Estate Investing Glossary

At Patch, our commitment to making things simple(r) doesn’t stop at the deal. Our real estate investing glossary is a fantastic resource where you can reference all the real estate investment industry jargon you might encounter from first call to closing and beyond.

Adjustable-Rate Mortgage (ARM)

A type of mortgage loan characterized by interest rates that automatically adjust or fluctuate in concert with certain market indexes. Generally, an ARM begins with an introductory or initial interest rate, which then may rise or fall, but monthly payments may not exceed the ARM loan cap.

Alternative Financing

Alternative financing refers to a particular type of financial service, namely sub-prime lending (that is lending to people with relatively poor credit) by non-bank financial institutions. Alternative financing allows smaller businesses and people with low credit to finance projects as traditional banks will most likely not approve their loans. Peer to peer lending is a form of alternative financing.

Alternative Investments

An investment that is not one of the three traditional asset types (stocks, bonds and cash). Alternative investments include hedge funds, managed futures, real estate, commodities and derivatives contracts. Alternative investments are favored mainly because their returns have a low correlation with those of standard asset classes. Because of this, many large institutional funds such as pensions and private endowments have begun to allocate a small portion (typically less than 10%) of their portfolios to alternative investments such as hedge funds. While the small investor may be shut out of some alternative investment opportunities, real estate and commodities such as precious metals are widely available

Amortization

The gradual paying off of a debt by periodic instalments. Example: a $100,000 loan is arranged at an 8% interest rate. The borrower pays $10,000 in the first year. Of that payment, $8,000 is for the interest owed, and the remaining $2,000 serves to amortize the loan balance. After that payment, the loan balance will have been amortized to $98,000.

Annual Percentage Rate (APR)

The truest cost of a home loan. Per the Truth in Lending Act, all mortgage lenders must disclose their APR. In the mortgage industry, APR may include fees such as documentation fees, private mortgage insurance and more.

Appraisal

“An estimate of value, generally made by a professional appraiser (certified to meet certain education, experience, and knowledge requirements) who uses a systematic approach or process (including the analysis of market data) in order to reach a conclusion. An appraisal of a property might be made not only to determine a reasonable offering price in a sale, but also to determine an appropriate loan size of a loan, to allocate a purchase price between land and building (improvements), to determine an appropriate amount of hazard insurance, or for estate tax purposes at the owner’s death.

3 major types of appraisals:

Sales Comparison Approach: Sales comparison approach compares compares a subject property’s characteristics with those of comparable properties which have recently sold in similar transactions. PoL uses this.

Cost Approach: In cost approach pricing, the market price for the property is equivalent to the cost of land plus cost of construction, less depreciation. It is often most accurate for market value when the property is new.

Income Approach: The income approach is computed by taking the net operating income of the rent collected and dividing it by the capitalization rate (the investor’s rate of return). It is most typically used for income producing properties.

Appreciation

The measurable value that increases on a home or property. Market improvements and home renovations often drive appreciation value.

ARV (After Repair Value)

After Repair Value (ARV) is the projected value of a property after repairs have been made to it, based on comparable properties in the area.

ARV% = (Price+Repair Cost)/After Repair Value

As-Is Value or AIV

As-Is Value means the value of the housing and related facilities as of the effective date of the appraisal. It relates to what physically exists and is legally permissible at the time of the appraisal and excludes all hypothetical conditions.

Average Daily Rate

Average Daily Rate represents the average rental income per paid occupied room within a given time period, usually the average realized room rental per day. ADR along with the property’s occupancy are the foundations for the property’s financial performance.

Bridge Loan

A short-term loan that is used until permanent financing can be arranged or an existing obligation can be satisfied. This type of financing allows the user to meet current obligations by providing immediate cash flow. The loans are short-term (up to two years) and are backed by collateral such as real estate. Bridge loans are common in the real estate market as there can often be a time lag between the sale of one property and the purchase of another, and bridge loans provide the time and flexibility to secure more advantageous long-term financing.

Buy Down

A situation in which a seller or lender kicks in a sum of money in order to lower the initial
interest rate on a home loan to make a sale more appealing for the buyer.

Capital Gain

Profit earned on an asset, such as a home or property.

Capitalization Rate (also known as Cap Rate)

Capitalization Rate, also known as Cap Rate, helps in evaluating a real estate investment and is the rate of return on a real estate investment property based on the expected income that the property will generate. This rate can be used to estimate the investor’s potential return on investment.

Formula:
Yearly Income/Total Value = Capitalization Rate

Cash Out

A mortgage-refinancing option in which an old mortgage is replaced by a new one with a larger amount than owed on the previously existing loan, helping borrowers use their home mortgage to acquire cash.

Co-Borrower

A borrower with good credit that agrees to take on shared responsibility for a home loan so that the primary borrower may purchase property.

Construction Draw

The draw period is a fixed amount of time (2 years) during which a borrower may “draw” upon available funds, up to a limit. Like a credit card, repaid funds are again available for withdrawal, during the draw period only.

Construction Loan Contigency

A construction contingency is the amount of money allocated to pay for additional or unexpected costs during the construction project. Typically, a 5-10% calculation of the construction budget should be allocated to your construction contingency.

Crowdlending

Crowdlending is when individuals lend you money. This is important because often times banks don’t want to lend money to entrepreneurs and small business owners. Crowdlending eliminates the banks as an intermediary and allows individuals to lend money to other individuals. Another name for Crowdlending is “peer to peer” lending or “crowdfunding.”

Day-Count Convention (30/360)

Day-count convention determines how interest accrues over time for a variety of investments including: bonds, notes, loans, mortgages, medium-term notes, swaps, and forward rate agreements (FRAs). This system is important in calculating accrued interest and present value. There are several different types of day-count convention methods. For example, a 30/360 day-count convention assumes there are 30 days in a month and 360 days in a year.

Debt Service

Debt service is the amount you pay on a loan in principal and interest over a period of time (Usually calculated for a year).

Debt Service Coverage Ratio (DSCR)

“Debt service coverage ratio is the amount of cash flow available to meet annual interest and principal payments on debt. This ratio is typically used by a lender when determining income property loans. A debt coverage ratio (DSCR) of 1.0 would mean the property is generating the same amount of income as the debt obligation (mortgage). It is not uncommon for lenders to require a DSCR of 1.2, which provides the borrower 20% of the monthly income to help cover additional expenses typical with rental properties.

General calculation:
Net Operating Income / Total Debt Service = DSCR

Deed of Trust

A legal instrument used in many states in lieu of a mortgage, where legal title to a property is vested to a trustee(s) to secure the repayment of a loan.

A deed of trust involves three parties: a lender, a borrower, and a trustee. The lender gives the borrower money. In exchange, the borrower gives the lender one or more promissory notes. As security for the promissory notes, the borrower transfers a real property interest to a third-party trustee. Should the borrower default on the terms of the loan, the trustee may take full control of the property to correct the borrower’s default.

Default

Failure to fulfill an obligation or promise, or to perform specific acts.

Delayed Draw Term Loan (DDTL)

A delayed draw term loan (DDTL) is a special feature in a term loan that lets a borrower withdraw predefined amounts of a total pre-approved loan amount. The withdrawal periods—such as every three, six, or nine months—are also determined in advance. A DDTL is included as a provision of the borrower’s agreement, which lenders may offer to businesses with high credit standings. A DDTL is often included in contractual loan deals for businesses who use the loan proceeds as financing for future acquisitions or expansion.

Due Dilligence

Reasonable effort to obtain accurate and complete information in advance of a real estate purchase. This usually refers to the inquiries made in advance of a purchase or investment in a property. Due diligence considers the physical, financial, legal, and social characteristics of a property and its expected investment performance. The underwriting of a loan or investment is a form of due diligence, in the sense that constitutes a relatively detailed risk assessment of that loan or investment (i.e. local market conditions and competition, environmental hazards).

Escrow

A financial instrument held by a third party on behalf of the other two parties in a transaction. The funds are held by the escrow service until it receives the appropriate written or oral instructions or until obligations have been fulfilled. Securities, funds and other assets can be held in escrow.

First Lien

A lien (often a deed of trust or a mortgage) that has priority over all other liens. In cases of foreclosure, the first mortgage will be satisfied before other mortgages.

Fix & Flip

A type of business / investment strategy involving the purchase of properties requiring some immediate repairs to attempt to make a profit by selling the house quickly at a higher price.

Foreclosure

A situation in which a homeowner is unable to make full principal and interest payments on his/her mortgage, which allows the lender to seize the property, evict the homeowner and sell the home, as stipulated in the mortgage contract.

Ground-up Construction Loan

A short-term loan for new home construction that is supplanted with a conventional
long-term home loan.

High-Density Population Area

Population density is the number of people per unit of area, usually quoted per square mile (or Kilometer). A high-density population area would typically be a major metropolitan city, or county.

Illiquid Asset

An asset that is not readily convertible to cash. Real estate is generally considered an illiquid asset because it may take an extended period of time to accomplish a sale, depending on market circumstances.

Interest

The charge for the privilege of borrowing money, typically expressed as an annual percentage rate (APR).

Lien

A claim upon a property that arises because of an unpaid debt related to that property and that operates as an encumbrance on the property until the debt is satisfied. A lien generally stays in effect until the underlying obligation to the creditor is satisfied. If the underlying obligation is not satisfied, the creditor may be able to take possession of the property involved.

LLC (Limited Liability Company)

A legal organizational form offering limited liability protection for the owners and which may be treated as a partnership for federal income tax purposes. An LLC is often used as a way to own real estate because it provides many of the legal advantages of a corporation along with the tax advantages of a partnership.

LTC (Loan to Cost Ratio)

A ratio used in commercial real estate construction to compare the amount of the loan used to finance a project to the cost to build the project. If the project cost $1 million to complete and the borrower was asking for $800,000, the loan-to-cost (LTC) ratio would be 80%. The costs included in the $1 million cost figure would be land, construction materials, construction labor, professional fees, permits and so on.

LTV (Loan to Value Ratio)

Lenders assess the LTV ratio to determine the level of exposure to risk they take on when underwriting a mortgage. When borrowers request a loan for an amount that is at or near the appraised value (and therefore has a higher LTV ratio), lenders perceive that there is a greater chance of the loan going into default. This is because there is very little equity in the property. As a result, in the event of a foreclosure, the lender may find it difficult to sell the home for enough money to cover the outstanding mortgage balance. Example: If a borrower receives a loan for $750,000 against a $1,000,000 purchase price of a property, the loan-to-value ratio is 75%.

Maturity

Maturity is the date on which the life of a transaction or financial instrument ends, after which it must either be renewed or it will cease to exist. The term is commonly used for deposits, foreign exchange spot trades, forward transactions, interest rate and commodity swaps, options, loans, and fixed income instruments such as bonds.

Mortgage

A debt instrument, secured by the collateral of specified real estate property, that the borrower is obliged to pay back with a predetermined set of payments. Mortgages are used by individuals and businesses to make large real estate purchases without paying the entire value of the purchase up front.

Example: Tom wants to buy a home, but needs a loan to complete the purchase. As collateral, Tom offers a mortgage on the property to a lender; if Tom later defaults on the loan, the lender has a lien on the property from the mortgage, and can take possession of the property.

Net Operating Income (NOI)

Net operating income (NOI) is a calculation used to analyze real estate investments that generate income. Net operating income equals all revenue from the property minus operating expenses.

A property might generate revenue from a number of sources (rents, parking fees, and other services such as vending and laundry machines). Operating expenses are those required to run and maintain the building and its grounds (insurance, property management fees, utilities, property taxes, repairs and janitorial fees).

NOI is a before-tax figure that also excludes principal and interest payments on loans, capital expenditures, depreciation and amortization.

Occupancy Rate

Occupancy rate is the number of units in a building that are rented compared to the total number of units in the building.

Example:
An apartment building has 25 units, 15 of which have been rented out. Therefore, the building would have a 60% occupancy rate.

Passive Income Investing

An investment strategy involving limited ongoing buying and selling actions. Passive investors will purchase investments with the intention of long-term appreciation and limited maintenance. Unlike active investors, passive investors buy a security and typically don’t actively attempt to profit from short-term price fluctuations. Passive investors instead rely on their belief that in the long term the investment will be profitable. Real estate is a common form of passive investing.

Peer to Peer Lending (P2P Lending)

A method of debt financing that enables individuals to borrow and lend money – without the use of an official financial institution as an intermediary. The advantage to the lenders is that the loans generate income in the form of interest, which can often exceed the amount interest that can be earned by traditional means (such as from saving accounts and CDs). Plus P2P loans give borrowers access to financing that they may not have otherwise gotten approval for by standard financial intermediaries. The method is not without its disadvantages as the lender has very little assurance that the borrower, who traditional financial intermediaries may have rejected due to a high likelihood of defaults, will repay their loan. Furthermore, depending on the lending system employed, in order to compensate lenders for the risk that they are taking, the amount of interest charged for peer to peer loans may be higher than traditional prime loans.

Personal Guarantee

Agreement that make one liable for one’s own or a third party’s debts or obligations. A personal guarantee signifies that the lender (obligee) can lay claim to the guarantor’s assets in case of the borrower (obligor) default. A personal guarantee allows a business owner to borrow by putting his or her personal finances on the line (the individual’s credit score and assets are at risk). A regulation made by the Securities and Exchange Commission, under the Securities Act of 1933, that sets forth conditions to be satisfied in order to qualify for a private offering exemption from registration.

Portfolio

A collection of investment real estate that typically comprises two or more rent-to-own properties, frequently homes that can be leased out, or properties that are used for short-term rentals. Investment portfolios may also include commercial or mixed-use properties that generate revenue from the rent charged to tenants.

Preliminary Title Report

A report issued by a title company before a transaction, stating a willingness to insure title upon closing.

Example: The buyer’s attorney arranged for a preliminary title report when the property was put under contract, to discover whether there were any legal or title impediments to be cleared before closing.

Principal

The amount of money raised by a mortgage or other loan that still remains after some of that amount may have been amortized by earlier payments. Principal can be contrasted to the interest paid on the loan.

Example: Harry arranged an amortizing loan of $100,000 principal amount at a 6% interest rate. The first monthly payment is $1,200 and includes $500 interest and $700 of principal amortization; following the payment, the principal balance be $99,300.

Rent Rolls

A register of rents including the names of tenants and the amount of rent they pay. This typically involves an official written record of names or events or transactions.

REIT (Real Estate Investment Trust)

A Real Estate Investment Trust, or REIT, is a real estate mutual fund, allowed by income tax laws to avoid the corporate income tax if it limits its investments to real estate or mortgages and meets certain other requirements such as annually distributing 90% or more of its income to shareholders. Some of these restrictions can limit the maneuverability of REITs, which also tend to focus only on “core” properties with limited capital appreciation potential.

REIT Investing

When you buy a share of a REIT, you are essentially buying a physical asset with a long expected life span and potential for income through rent and property appreciation. This contrasts with common stocks where investors are buying the right to participate in the profitability of the company through ownership. When purchasing a REIT, one is not only taking a real stake in the ownership of property via increases and decreases in value, but one is also participating in the income generated by the property. This creates a bit of a safety net for investors, as they will always have rights to the property underlying the trust while enjoying the benefits of their income.

REIT Investments

Individuals can invest in REITs either by purchasing their shares directly on an open exchange or by investing in a mutual fund that specializes in public real estate. An additional benefit to investing in REITs is the fact that many are accompanied by dividend reinvestment plans (DRIPs). Among other things, REITs invest in shopping malls, office buildings, apartments, warehouses and hotels. Some REITs will invest specifically in one area of real estate – shopping malls, for example – or in one specific region, state or country. Investing in REITs is a liquid, dividend-paying means of participating in the real estate market.

Rehab Project

The process of restoring and improving a property to a satisfactory condition through repair and renovation. Rehabs bring a property back to a preferable manner of living which makes contemporary use possible while still preserving significant character-defining features. This also includes adaptive use.

Risk

Uncertainty or variability; the possibility that returns from an investment will be less than forecast, or that invested principal might be lost. Diversification of investments provides some protection against risk.

Example: Types of risk in real estate include (1) business risk, involving the project type, its management, and its market area, and how each of these factors might affect rents, vacancies and operating expenses; (2) financial risk, meaning both the uncertainty of the equity return when debt financing is used and the variability of interest rates that might affect a property’s debt service or its ultimate sale price; (3) inflation and other universal “systemic” risks like war or significant political changes, (4) liquidity risk, meaning whether (and when) the investment can be “”cashed out,”” and (5) variance or sensitivity risk, referring to the degree of variability of any of the foregoing risks.

Risk vs. Return

A financial concept that attempts to compare the potential fluctuations of an investment with the projected return associated with it. Increased risks require that an investor demand increased returns in compensation; people don’t normally accept the same rate of return on a very risky investment that they can already get on a low-risk investment.

Example: An expected return of two (2) percentage points above the rates paid by U.S. Treasury bonds may be considered sufficient reward for investing in mortgage securities if the historical default rate of such securities has been at 1%.

Example: An expected return of ten (10) percentage points above the U.S. Treasury rates may be needed to invest in unsecured credit card debt, if the historical default rate on such debt has been at 5%.

SEC Syndication

The Commission is adopting amendments to the rule under the Investment Company Act of 1940 that permits a registered investment company (“”fund””) that has certain affiliations with an underwriting participant to purchase securities during an offering. The amendments expand the exemption provided by the rule to permit a fund to purchase U.S. government securities in a syndicated offering. These amendments are intended to respond to recent changes in the method of offering certain U.S. government securities.

Self-Directed IRA (SDIRA)

An investing tool used by individuals to earn and earmark funds for retirement savings. There are several types of IRAs including Traditional IRAs and Roth IRAs.

Some investment types, such as life insurance, are still not permitted in an IRA. In addition, investments cannot be employed for personal use or gain. For example, an investor cannot hold real estate that is personally used in a self-directed IRA. It is the responsibility of the investor to comply with all IRS regulations.

Source: Investopedia

Title

Evidence that the owner of real property is in lawful possession thereof; it is evidence of ownership. Usually a property owner transfers his title by means of a legal document called a “deed,” which must be in writing and meet other local requirements. A deed should convey good and marketable title; “good” means that the title is valid, and “marketable” means that it is reasonably free from doubt or litigation, so that it can be readily sold.

Example: Title to land does not mean merely that a person has the right of possession, because one may have the right of possession but not have title. Title is evidence of true ownership of the land, with all the rights that signifies.

Example: Karen sold land to Susan. Title to the property was transferred at closing by the deed that Susan received.

Title Insurance

An insurance policy that assures good title is transferred in the course of a sales or financing transaction. This insurance covers the legal fees and expenses that may be necessary if a claim is made against one’s ownership of the property. Different title policies offer different extents of coverage; for example, one can purchase “standard” coverage or “extended” coverage.

There are two common types of policies: a lender’s policy that protects a lender (or the “mortgagee”) on the property, and a buyer’s policy that protects the buyer (or the “mortgagor”).

Value-Add

Value-add generally refers to a property that is currently in less than stellar condition and in need of improvements that are of somewhat higher risk, such as performing more-than-usual renovations like upgrading exteriors and interiors and curing deferred maintenance. The value-add categorization implies higher risk than the category of core plus, but less than opportunistic.

Yield

Yield measures the profitability of an investment over a set period of time, often annually. The yield is the income the investment returns over time, typically expressed as a percentage. Yield is forward-looking and measures the income, such as interest and dividends, that an investment earns and ignores capital gains.