Basic Terms and Concepts Flashcards
(40 cards)
Present Value
The cash value today of cash received at some fixed future date. Impossible to predict future value exactly, easier to assess in today’s dollars.
Net Present Value
One method for evaluating the financial desirability of a proposed investment by comparing (1) the present value of the income stream expected from the proposed investment, with (2) the minimum return on investment that we, the investor will accept.
Discount Rate
Variable used to determine the present value of a future payment. Similar to an interest rate. Consists of (1) basic interest rate, (2) expected rate of inflation, and (3) risk factor
Future Value
The value of an asset or cash at a specified date in the future that is equivalent in value to a specified sum today.
Discounted Cash Flow
The present value of a series of cash payments received at periodic future dates, i.e., the present value of an income stream
Internal Rate of Return
The discount rate that makes the present value of all future cash flows (i.e., the income stream) equal to the initial cash investment. The discount rate that will produce a Net Present Value of a series of future cash flows of zero. IRR is the investor’s yield on that investment.
Income Stream
The property’s anticipated cash flow. Generated by rent.
Cap Rate
Expresses the relationship between income at a particular time and the value of the property at that time.
The discount rate applied to the anticipated profits from investing in the real property. The rate of return that expresses the relationship between one year’s income and its corresponding value.
An estimate of the project’s worth following completion of construction. Determined by looking at recent sales prices and NOIs for comparable buildings/projects in the area. The lower numeric value of the cap rate, the less risky the project, and the more valuable the property.
Net Operating Income
Combined revenues, rents etc. from which current operating costs are subtracted. Does not include debt service.
Total annual revenues less total annual operating expenses.
Stabilized Property
Property that is already built, with a stable operating and revenue history, and that does not require significant renovation.
Cash-on-Cash Return
The estimated annual cash payment from operations to the owner, stated as a percent of the owner’s total investment (cash return / investment). This should equal 8% or more on new developments.
Return on Equity
Cash-on-Cash Return is the same. The estimated annual cash payment from operations to the owner, stated as a percent of the owner’s total investment (cash return / investment)
Leverage
People will take a loan if it will raise their return on the investment.
Debt Coverage Ratio
The lender’s expression of the risk it sees in the development. Higher the DCR, the lower the amount of Annual Debt Service and the lower the original loan.
The amount of cash flow available to meet annual interest and principal payments on debt.
The formula for debt coverage ratio is net operating income divided by debt service. The debt coverage ratio is used in banking to determine a companies ability to generate enough income in its operations to cover the expense of a debt.
Annual Debt Service
The total amount of all interest and principal paid on all of the property’s loans throughout the year.
Debt service refers to the periodic payments of principal and interest to the lender made by the entity that owns the development.
Loan-to-Value Ratio
Serves to assure the lender that it will recover its principal and accrued but unpaid interest in the event the development fails to generate sufficient NOI to remain current on the loan.
Expresses the ratio of a loan to the value of an asset purchased. The term is commonly used to represent the ratio of the first mortgage lien as a percentage of the total appraised value of real property.
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.
= Loan amount / Value of Property
Pro forma
Financial spreadsheet prepared by the developer
Soft vs Hard Costs
Hard costs are bricks and mortar costs, such as construction and building materials. Site preparation, building permits, etc.
Soft costs are fees, cost of purchase, appraisal, market study, environmental assessment, accounting, architectural plans, etc
Reserves for Replacements
Money set aside as a reserve to replace worn-out capital items, such as replacing roofs. Separate from ordinary maintenance expenditures.
After-tax Cash Benefit
The intent is to discover the amount of money that can be deposited in the bank at the end of each year.
A measure of a company’s cash flow after all taxes are paid. It is calculated by taking the net income and adding back in the value of all non-cash expenses, notably amortization and depreciation. Publicly-traded companies with a high cash flow after taxes are in a better position to distribute cash dividends than those with a low cash flow after taxes. In addition to this, it is also used as a measure of general performance and financial health.
Developer’s Fee
Compensation to the developer for the time and risk involved to develop the project. It is typically based on the size of the project, the total development cost and the risk associated with the project. A percentage of the project cost, typically 10-15%.
The principal short-term financial reward that the developer receives. Paid by the entity that owns the property. The fee is what remains from the sum of the cash proceeds from the mortgage loan and the sale of equity after all third party expenses relating to the development of the property have been paid.
Syndicator
An equity sales specialist. Syndicator will advise him on the sale of the equity and will serve as his agent and implementer of the equity sales process.
a real estate syndicate is simply the pooling of money from numerous investors and organizing these funds as a whole into real estate projects.
Accrual Basis Accounting
Accrual accounting is considered to be the standard accounting practice for most companies, with the exception of very small operations. This method provides a more accurate picture of the company’s current condition, but its relative complexity makes it more expensive to implement. This is the opposite of cash accounting, which recognizes transactions only when there is an exchange of cash.
The general idea is that economic events are recognized by matching revenues to expenses (the matching principle) at the time in which the transaction occurs rather than when payment is made (or received). This method allows the current cash inflows/outflows to be combined with future expected cash inflows/outflows to give a more accurate picture of a company’s current financial condition.
Cash Basis Accounting
An accounting method where receipts are recorded during the period they are received, and expenses are recorded in the period in which they are actually paid. Cash accounting is one of the two forms of accounting. The other is accrual accounting, where revenue and expenses are recorded when they are incurred. Small businesses often use cash accounting because it is simpler and more straightforward, and it provides a clear picture of how much money the business actually has on hand. Corporations, however, are required to use accrual accounting under generally accepted accounting principles.
A drawback of cash accounting is that it may not provide an accurate picture of liabilities that have been incurred but not yet paid for, so the business might appear to be better off than it really is. At the same time, cash accounting means that a business that has just completed a large job for which it is awaiting payment may appear to be less successful than it really is, because it has expended the materials and labor for the job but not yet reaped the rewards.
