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1031 Exchange

Under Section 1031 of the Internal Revenue Code, like-kind property used in a trade or business or held as an investment can be exchanged tax-deferred. Under a Section 1031 exchange, real estate is traded for other like-kind property. All capital gains taxes are deferred until the newly acquired real estate is transferred or sold in a taxable transaction.

A

Absorption Rate

The rate at which available, move-in ready units are leased within a specified real estate market during a defined period of time.

Accredited Investor

A person that is qualified to invest in apartment syndications by satisfying one or both of the requirements regarding income or net worth.

A) Have an individual annual income of $200,000, or $300,000 in joint income, within the last two years.

B) Have a net worth exceeding $1 million either individually or jointly with a spouse. This does not include one's primary residence.

Acquisition Fee

The compensation that the general partner in a syndication earns for sourcing, evaluating, arranging financing, and closing on the asset. This compensation is paid to the general partner by the new buying partnership.

Active Investing

The finding, underwriting, and closing on an apartment building using one's own equity and executing the business plan through from inception to completion.

Amortization

The process in which a mortgage loan is paid off over time through fixed payments that include principal and interest.

Annualized Return

The return on an investment divided by the number of years the investment is held.

Apartment Syndication

Instead of saving up for years and years to purchase a rental property, you can enter into a temporary group investment partnership, in which you pool your money together with other investors to buy larger rental property, such as an apartment complex.

This would be very difficult for the individuals involved to do by their selves, but by pooling their resources together they can share in the rewards and risks.

Apartment syndication is generally a partnership between the general partners, also referred to as the syndicators, and the limited partners, also referred to as the passive investors, to acquire, manage, and eventually sell an apartment asset.

Appraisal

A report created by an appraiser to assess the market value of a property using the income approach, the sales comparable approach, and the cost approach.

Appreciation

An increase in the value of an asset over time. There are two main types of appreciation; market appreciation and forced appreciation.

Market appreciation happens when the overall market goes up and rental rates and occupancy naturally increase. When rental rates and occupancy gradually increase, the income and value of the property increase as well. This type of appreciation is based on external market factors, which can't be controlled.

Forced Appreciation occurs when the net operating income of a property is increased by increasing the revenue or decreasing the expenses. This type of appreciation is common with value-add renovation projects and changes in operational processes. This type of appreciation is more predictable and controllable.

Asset Management Fee

A recurring fee that is paid from the property revenues to the general partner for overseeing the property and asset as a whole.

B

Bad Debt

The uncollected money that a tenant owes upon moving out of a rental unit.

Breakeven Occupancy

The occupancy rate at which a property goes from having an operating deficit to an operating surplus. This occupancy rate needs to at least cover all expenses of the property.

Bridge Loan

Typically, a short-term mortgage loan used until the borrower is able to secure a longer-term, permanent financing option. These loans usually have terms of six months to three years with higher interest rates, and interest only payments. Bridge loans are also referred to as gap financing, interim financing, or swing loans.

Bridge loans are often used for apartment communities that need to be repositioned, heavily renovated, or stabilized, which may initially disqualify the property from a traditional long-term loan.

C

Capital Expenditures (CapEx)

The funds used by the managing company or partners to acquire, improve, and maintain a property. An expense is categorized as CapEx if it maintains, extends, or improves the useful life of a property and is capitalized – spreading the cost of the expenditure over the useful life of the asset.

CapEx isn't the same as operating expenses, which are required to fund the ongoing operational costs and are considered short-term expenses. Operating expenses are fully tax-deductible in the year they are incurred, while CapEx are expensed through depreciation over the life of the asset.

Capitalization Rate (Cap Rate)

The rate of return on a real estate investment property based on the expected income that the property is expected to generate. The cap rate is calculated by dividing the net operating income by the current market value of a property.

The cap rate is used to help estimate an investor's potential return on their investment. When looking to acquire a property, a higher cap rate is better, as it implies a lower purchase price, and when selling a property, a lower cap rate is better, as it implies a higher purchase price.

Cap Rate = (Net Operating Income) / (Current Market Value of the Property)

Example: Assume we bought an apartment for $1M with an annual return of $70K. The cap rate on this property would be ($70,000) / ($1,000,000) = 0.07, or 7%.

Cash Flow

The revenue remaining after paying the operating costs and any debt service payments of the property.

Cash Flow = (Revenue) - (Operating expenses, debt service payments, CapEx, vacancies, etc.)

Example: Assume you own a duplex with an annual revenue of $46,000 and operating expenses of $36,000. Your cash flow would be ($46,000)-($36,000) = $10,000/yr, or $833/mo.

Cash-on-Cash Return (CoC)

The rate of return, often used in real estate transactions, is a ratio of annual before-tax cash flow to the total amount of money invested. It is calculated by dividing cash flow produced by the property by the initial total amount invested. It is used to help evaluate the cash flow of an income-producing property.

CoC = (Annual Cash Flow) / (Total Initial Amount/Equity Invested)

Example: If you invested $100k in an apartment syndication deal and you realize returns of $8k/yr, then your CoC would be ($8,000) / ($100,000) = 0.08, or 8%.

Closing Costs

The costs, beyond and not including the purchase price, that are needed to complete a real estate or financing transaction. These costs may include origination fees, application fees, processing fees, underwriting fees, recording fees, attorney fees, credit report fees, etc.

Concessions

An incentive, such as credit towards rent, waived application fees, and discounts on any cost that a tenant has to pay, in order to attract prospective clients to sign a lease.

Cost Approach

A method in which the assessed value of a property is based on the costs to rebuild the exact property from scratch.

D

Debt Service

The annual mortgage amount required to be paid to the lender, which includes principal and interest. Principal is the original sum of the loan that the borrower took out and the interest is the additional charge accrued for the ability to borrow the principal amount.

Debt Service Coverage Ratio (DSCR)

The DSCR is a ratio that measures the amount of available cash flow that will be able to cover the annual principal and interest debt obligations of the loan. Commercial mortgage lenders use the DSCR to evaluate and qualify financing for deals. The DSCR is calculated by dividing the net operating income by the total debt service.

A DSCR ratio of 1 means that the net operating income is enough to cover the total amount of the debt service. A lender would typically want to see a DSCR of 1.2-1.4.

DSCR = (Net Operating Income) / (Total Debt Service)

Example: If a property has a NOI of $120,000 with an annual debt service of $100,000, the DSCR on this property would be ($120,000) / ($100,000) = 1.2x.

Defeasance

Allows for the cancellation of a mortgage loan upon repayment of the debt through a substitution of collateral.

Depreciation

A decrease or loss in the value of an asset due to wear and tear, age, or other causes.

Distressed Property

A non-stabilized apartment property that has an economic occupancy rate below 85%. The economic occupancy rates are often much lower in the case of apartment properties that have mismanagement problems, tenant issues, deferred maintenance, or outdated exteriors and interiors.

Distributions

The portion of the property's income that goes to the limited partners in a syndication deal. These can be given out on a monthly, quarterly, annual schedule, or when the property is refinanced and/or sold.

Due Diligence

The process of examining and evaluating a property, its financial records, and any related documents to confirm seller representations and to satisfy lender underwriting requirements. These tasks can include inspections, appraisals, surveys, and title work.

E

Earnest Money

A deposit for a portion of the purchase price of a property that the buyer puts in escrow to show good intention and the ability to execute the purchase of the property. This deposit is credited towards the acquisition cost that the buyer pays at closing.

Economic Occupancy Rate

The proportion of total potential gross revenue that is collected compared to the actual revenue collected. The economic occupancy rate is determined by dividing the actual revenue collected by the gross potential income.

Economic Occupancy Rate = (Actual Revenue Collected) / (Gross Potential Income)

Example: If the total potential gross revenue for a property in a given month was $100,000, but the property only collected $92,000, the economic occupancy for that month is ($92,0000) / ($100,000) = 92.0%.

Economies of Scale

Applied to real estate, the economies of scale refers to the increased cost advantages that result from the increase in number of units. This cost advantage is due to buying in bulk, resulting in discounted prices per unit.

Example: Buying one washer and dryer set for a single-family home for $700, versus buying 100 sets for $55,000, or $550/unit, for a multifamily property. This would save $150/set for the multifamily owner.

Effective Gross Income (EGI)

The gross potential income (GPI) that a property generates from base rent, and other miscellaneous income, minus the lost revenue from collection losses, vacancies, concessions, model units, bad debt, etc.

EGI = (GPI) – (Vacancy) + (Miscellaneous Income)

Example: GPI = $216,000 Vacancy @ 10% = $21,600 Other Income = $3,120 Effective Gross Income = $197,520

Employee Unit

An apartment unit that is leased to an employee at a discounted rental rate.

Equity Investment

The upfront cash that is put into the purchase of an investment. In apartment syndication, this initial capital typically goes towards the down payment for the mortgage loan, closing costs, financing fees, funding of the operating account, and compensation earned by the general partners for structuring the deal.

Equity Multiple (EM)

A method to calculate the total cash distribution that is received from an investment property in proportion to the total amount of equity invested. This EM will provide a rate of return by dividing the total net profit and the equity investment by the equity investment. A value below 1 indicates that the investment is losing money, on the other hand, a value greater than 1 indicates that the investment is making money.

Equity Multiple = (Total Cash Distributions) / (Total Equity Invested)

Example: An equity multiple of 2.5x implies that for every $1 invested, you will see a return of $2.50 over the life of the investment.

Exit Strategy

A plan of action created by the general partners to sell the apartment property at the end of the business plan.

F

Fair Market Value (FMV)

The selling price/market value of a property calculated by dividing the net operating income (NOI) by the capitalization rate (CAP).

Example: If a property has a NOI of $1M and a CAP rate at 6%, the FMV would be ($1,000,000) / (0.06) = $16,666,666.

Financing Fees

The upfront fees paid once by the borrower to the lender for organizing and funding the loan.

G

General Partner (GP)

In apartment syndications, a general partner is the party within a partnership that has unlimited liability and is typically the managing partner. The general partner is often referred to as the syndicator or sponsor whose role is to manage the apartment project, as well as play an active role in the daily operations of the project.

Gross Potential Income

The potential amount of revenue that an apartment community could hypothetically produce if occupancy was at 100% with all leases at market rental rates plus any additional revenue.

Gross Potential Rent (GPR)

The potential amount of revenue that an apartment community could hypothetically produce if occupancy was at 100% with all leases at market rental rates.

Gross Rent Multiplier (GRM)

A ratio of the purchase price of a property in proportion to the annual gross potential rent. The GRM is the number of years that it would take for a property to pay for itself in gross received rent. This ratio is often used to compare investments properties with each other and to evaluate if the purchase price of the property is set at a fair amount.

GRM = (FMV) / (Potential Gross Income)

Example: If a property is valued at $5M with a potential gross income of $500K, the GRM would be ($5,000,000) / ($500,000) = 10.0, or 10 years for the property to pay for itself in gross received rent.

Guarantee Fee

A fee to compensate a loan guarantor at closing for signing and guaranteeing the loan.

H

Holding Period

The amount of time from the purchase of the apartment to the sale of the apartment that the general partner plans the partnership will possess ownership of the property.

I

Income Approach

A real estate valuation method used to estimate a fair market value based on the income that a property generates. It is based on the capitalization rate and the net operating income of a property.

Property Value = (Net Operating Income) / (Capitalization Rate)

Interest Rate

The amount charged by a lender to a borrower for using their funds to finance a deal.

Interest-Only Payment

A monthly mortgage payment in which the borrower only pays the interest, not the principal balance. The balance on the mortgage loan may be paid upon sale of the property, at refinancing, or at maturity of the loan.

Internal Rate of Return (IRR)

The discount rate at which the net present value (NPV) of a set of cash flows equals zero. The IRR is the rate needed to convert the sum of all future uneven cash flow to equal the equity investment. It is the compounded annual rate of return at which a real estate investment grows or shrinks by a percentage per year, evenly, over the life of the investment.

Generally, the higher a property's internal rate of return, the more desirable the property is.

J

K

Key Principal

A person vital to the ongoing success of an apartment syndication investment.

L

Lease

A legal contract between a landlord and a tenant to give the tenant the right to occupy an apartment unit for a defined period of time and at a specified rental rate under the terms outlined in the contract.

Letter of Intent (LOI)

A non-binding term sheet created by a buyer to describe and propose purchase terms and conditions under which they will purchase a property.

Limited Partner (LP)

A partner whose liability is limited to the extent of their share of ownership. Typically, in an apartment syndication deal, the limited partner is a passive investor who has contributed capital to the deal, but does not partake in managing the property.

London Interbank Offered Rate (LIBOR)

The most widely used global "benchmark" interest rate at which some of the world's leading banks borrow funds from other banks in the London market for short-term loans. LIBOR is a reference rate for calculating interest rates for commercial loans.

Loan-to-Cost Ratio (LTC)

The LTC ratio shows the value of the anticipated loan amount and capital expenditure costs divided by the appraised value of the apartment.

Loan-to-Value Ratio (LTV)

The ratio of the value of the loan amount divided by the property’s appraised value.

Loss-to-Lease (LtL)

The lost revenue due to the difference between the market rent and the actual rent that is specified in the lease. LtL is calculated by dividing the gross potential rent minus the actual collected rent by the gross potential rent.

M

Market Rent

The rent that a landlord could reasonably charge in the open market and expect a tenant to pay, without rent or income restrictions, or rent subsidies. This is based on the rental's location, amenities, features, and rental rates at similar apartment communities.

Metropolitan Statistical Area (MSA)

A geographical region grouped by adjacent counties and cities which contain a substantial population that have a high degree of integration with neighboring communities. A MSA is used to create a population census and for the collection of related statistical data.

Example: The Miami Metropolitan Area is a MSA which contains Miami, Fort Lauderdale, and West Palm Beach, along with three different counties and dozens of cities.

Mortgage

A loan from a financial institution to assist a borrower in purchasing a property. The loan is secured by the property until the debt is paid in full.

N

Net Operating Income (NOI)

The annual revenue that a property generates minus ALL expenses (excluding debt services, depreciation, and CapEX).

Net Operating Income = (Gross Rent) - (Vacancy & Credit Losses) + (Other Income) - (Operating Expenses)

O

Offering Memorandum

Commonly referred to as the private placement memorandum, the offering memorandum outlines the risks, terms, and objectives of an investment, as well as the syndicators’ business operations and conditions.

Operating Account Funding

Capital reserved to cover additional unexpected issues such as a decrease in the occupancy rate, large tax or insurance payments, or higher than anticipated capital expenditures.

Operating Agreement

A key document used to outline the financial and functional decisions, rules, regulations, provisions, responsibilities and percentages of ownership of the limited partners and general partners in an apartment syndication deal.

Operating Expenses

The costs to run and maintain an investment property. In apartment syndications, these expenses usually include administrative, maintenance, payroll, repairs, capital reserves, contractors, marketing, utilities, management fees, property taxes, and insurance.

P

Passive Investing

The investing strategy of putting your capital into an apartment syndication that is entirely by the general partner.

Permanent Agency Loan

A long-term mortgage loan guaranteed by government-sponsored agencies, like Fannie Mae and Freddie Mac, with amortized loan terms of 3-30 years.

Physical Occupancy Rate

The percentage of the total units that are successfully rented. It is calculated by dividing the total number of occupied units by the total number of units.

Preferred Return

This is the first claim on profits (promised to investors) until a target return has been achieved. This is the return given to the limited partners before the general partners receive any payment. This helps minimize the risk for investors.

Example: If an individual invests $100K in a syndication deal and the general partner promises an 8% preferred return, the investor will receive $8K cash flow annually before the general partner receives any payout.

Prepayment Penalty

A clause in a mortgage contract which stipulates a penalty for paying a loan off early.

Price Per Unit

The cost for each individual apartment unit when purchasing an apartment community. It is calculated by dividing the purchase price by the number of units.

Example: If a property has 100 units and a purchase price of $1M, the price per unit would be $10,000.

Private Placement Memorandum (PPM)

A legal document that is provided to prospective investors to outline the terms of an investment, specifically the potential risks involved. The document outlines the offering and terms, the general partner information, asset description, risk factors, the use of proceeds, the legal agreement, and the subscription terms amongst other important details.

Pro-forma

An itemized projected budget to forecast anticipated revenue and expenses for the next 1-5 years.

Profit and Loss Statement (T-12)

A financial statement depicting detailed information about an entity's operating performance, net income, rental income, and operational expenses over the last 12 months.

Property and Neighborhood Classes

A system used to rank property classes and neighborhood classes from A-D depending on several factors. Property classes are determined by the age of the property, condition of the property, its features, and the amenities offered. Neighborhood classes are determined by median income, median home values, demographics, crime rates, and the ranking of local schools.

Property Management Fee

A recurring monthly cost for using a property management company to oversee and manage the daily operations of the property.

Q

R

Ration Utility Billing System (RUBS)

A method that allows an owner or property manager to divide the utility bill among tenants based on occupancy, square footage, or combination of the two. This can drastically decrease expenses and improve the NOI.

Recourse

The right of a lender to pursue the debt that is owed to them. A full recourse loan may expose personal assets above and beyond the collateral in the case of loan default.

Refinance

The replacement of an existing debt obligation on a property with a new loan with different terms.

Refinancing Fee

A fee earned by the general partner for arranging a refinance on an apartment.

Rent Comparable Analysis (Rent Comps)

The process of utilizing the rental rates of similar, nearby properties in relation to the subject property to gauge the rental rates that the market can be expected to bear for the units at the subject property.

Repositioning

A strategy used by the owners or general partners of a property to change the position of the asset in a market by adding value, addressing previous operational issues, and/or rebranding the property.

Rent Premium

The rental amount in excess of the market rent that results from a rent increase after interior and/or exterior upgrades and renovations.

Rent Roll

A document that accounts for all of the information for each unit in an apartment community. This information will include the tenants' names, the unit numbers, the square footage, the actual rent, the market rent, the amounts of the deposits, move-in dates, lease-start dates, lease-end dates, and the current status of each unit.

Reversion / Terminal CAP

The expected cap rate used to estimate the resale value of a property at the end of the investment holding period. It is one of the benefits that an investor can expect to receive at the time of disposition of a property.

S

Sales Comparison Approach

The typical method for estimating an apartment's value based on recent, similar apartment sales in the area.

Sales Proceeds (Net)

The profit realized upon the sale of an apartment community.

Subject Property

The apartment that is being evaluated for purchase.

Submarket

A smaller, defined geographic area within a market, like a neighborhood or suburb.

Subscription Agreement

An agreement between the LLC that owns the apartment community and a limited partner, promising that the LLC will sell a specific number of shares to a limited partner at an agreed upon price, with the promise from the limited partner to pay the agreed upon price for the shares.

T

U

Underwriting

The process of evaluating an apartment community to determine the value, status, potential, risks, and projected returns.

V

Vacancy Loss

The amount of potential revenue lost due to vacant units.

Vacancy Rate

The percentage of unoccupied units in an apartment community. It is calculated by dividing the total number of vacant units by the total number of units.

Value-Add Property

An apartment community that offers the potential to increase the cash flow and FMV through renovations, rebranding, new management, or better operational practices.

W

Waterfall Structure

A method for splitting profits amongst partners in a syndication deal, allowing for profits to follow an uneven distribution. The payouts change when previously agreed upon return hurdles are met.

Example: An investor is paid 100% of profits until a preferred return (return hurdle) of 8% is reached, after that point the profits are split 70/30 between the limited partners and the general partner.

X

Y

Yield Maintenance

A prepayment penalty paid by the borrower in the event that the principal on a loan is paid off early. This penalty allows the lender to attain the same yield that the lender would have gotten if the borrower made payments until the maturity of the loan.

Z