Example: Tenants may ask for an abatement in rate if their use of the property has been interrupted or inhibited by actions of the landlord (like renovation work).
Example: Cities may offer a tax abatement to businesses contemplating moving to the city.
Example: A total of 1,000 new homes are available for sale on the market. During the year, 100 homes have been sold; an equal number may have come on to the market, but this serves only to keep the baseline constant. The annual absorption rate is 10% (100 / 1,000).
Example: Charles sells his house to Bob, who would like to assume the existing mortgage. Charles fails, however, to notify the lender of the sale -- and the mortgage states that the full principal balance amount accelerates unless the lender approves of the sale. Charles must now pay the full balance of the principal amount of the loan.
• an individual with income exceeding $200,000 in each of the two most recent years (or joint income with his/her spouse exceeding $300,000 in each of those years) and a reasonable expectation of reaching the same income level in the current year; OR
• an individual with a net worth (or joint net worth with his/her spouse) exceeding $1 million, excluding the person's primary residence.
For additional information on who qualifies as an accredited investor, including how an LLC, Corporation, or Trust can qualify as “accredited investors,” see http://www.sec.gov/answers/rule506.htm.
Example: A person obtains an adjustable-rate mortgage to finance the purchase of a home. At one-year intervals, the lender may adjust the rate of interest on the loan in accordance with an established index.
Example: Charles buys a lot for $100,000. He erects a retail facility for $600,000, then depreciates (for tax purposes) the improvements at the rate of $15,000 per year. After 3 years his adjusted tax basis is $655,000 ($100,000 + $600,000 - (3 x $15,000)).
Example: Big Buy Foods is the anchor tenant in a retail center. The anchor tenant, because it has drawing power to bring customers to the center, normally pays less rent per square foot than an ancillary tenant.
Example: The tailor shop, hairstylist, and pet store are often ancillary tenants in a neighborhood shopping center; the supermarket, on the other hand, would often be the anchor tenant.
Example: Henry purchases a building from Michael with the understanding that the building is to be conveyed as is. When Henry discovers that the roof leaks, Michael is not legally responsible for repairs.
Example: Dan sells a home with an assumable loan to Walter. Walter takes over the payments of the loan and accepts liability under the mortgage promissory note.
Example: A current loan balance of $95,000 means that loan payments have reduced the outstanding debt to that amount.
Example: A balance of $25,000 in a depositor savings account represents the amount deposited, plus interest earned, less any amount withdrawn.
Example: A debt requires interest-only payments annually for five (5) years, at the end of which time the principal balance (a balloon payment) becomes due.
Example: Claire purchases land for $100,000 and erects a store for $800,000. Her tax basis is $900,000. If she then sells the property for $950,000, she has a $50,000 gain. If she had earlier claimed depreciation for a total of $50,000, however, then her tax basis would have been adjusted -- reduced -- by that $50,000, so that now she would have a total gain of $100,000. Claire thus would have gained tax benefits in early years, but will be subject to some degree of depreciation recapture at the time of sale, depending on how the depreciation was calculated.
Example: Mortgage loan interest rates are 6.25% this week. They were 6.75% last week. The decrease was 50 basis points (675 minus 625 equals 50).
Example: Each of 100 investors contributes $5,000 into a project. The sponsor has not yet located the properties to be purchased, so the investment money is said to be placed in a blind pool.
Example: A developer with an outstanding construction loan is in the process of negotiating better terms for permanent financing. She has arranged for a bridge loan to pay off the construction loan when it is due, and to tide her over until the permanent financing is arranged, at which time the bridge loan will be repaid.
Example: A person wanting to sell or lease property often engages a broker to arrange the sale or to locate tenants. A broker may also be engaged by a prospective buyer or tenant to locate acceptable property.
Example: Because the Waltons had recently had their house appraised to secure a home equity loan, they were content with a broker's price opinion when they decided to list it for sale.
Example: Jones & Smith are partners. In the event that Jones dies, Smith has agreed to buy Jones' interest for $100,000. If Smith dies first, Jones will buy his interest for $25,000.
Example: A property that has a gross income of $300,000 and operating expenses of $100,000 (for a net operating income of $200,000), and a purchase price of $2,000,000 would be calculated as:
Net Operating Income ÷ Purchase Price = $200,000 ÷ $2,000,000 = 10.0% cap rate.
Since cap rates convert an income stream to value, the above calculation can be re-figured so that a given income stream and an assumed cap rate can be used to estimate the value of a comparable property, or even to estimate the future value of a property. Investors often use cap rates to convert future projected income streams into that property's future value (and thus its anticipated sales price at that time).
Example: Investors in Money Pit, LLC were asked, in a capital call, for an additional $1 million to cover company deficits brought about by poor budgeting, lack of cost controls, and project "bleeding."
Example: Karen buys an investment property for $100,000 from which she earns ordinary income of $8,000 annually. After three years, she sells the property for $140,000. The $40,000 gain on sale is reported as a long-term capital gain on her tax return and is taxed at a rate that is less than the tax rate on the rental income she had earned earlier.
(Net operating income less debt service) / initial equity investment = ($150,000 - 50,000) / $1,000,000 = 10% cash on cash return
Example: Although real estate brokers and agents may not perform appraisals in most states because they are not appropriately certified or licensed), often estimate the value of a subject property using a comparative (or competitive) market analysis in order to help their clients set listing prices and agree on selling prices.
Example: $100 deposited in a 5% savings account earns $5 interest the first year. Its second-year earnings are 5% of $105,or 5.25%. Each year, interest is received on previously earned but undistributed interest, so interest compounds.
Example: A credit report showing no late mortgage payments within the last 12 months may well mean that a person will be assigned a good credit score (perhaps a FICO score of 660 or above). This would be a good credit rating to have when applying for a new loan.
Example: With a credit score above 720, Ms. Phillips was able to arrange a loan at a prime (favorable) mortgage rate.
Example: A loan of $100,000 calls for 300 equal monthly payments to fully amortize the principal. Interest is 8% annually. The monthly payments are $771.82. The annual debt service is the sum of the 12 monthly payments, or $9,261.84.
Example: In exchange for the agreed-upon terms of a purchase contract (which might include the payoff of an older loan on the property), at the closing of escrow the seller delivers a deed to the buyer.
Example: Bob borrows $50,000 on his property from lender Larry. Bob provides a deed of trust that is held in the name of Honest Abe, a trustee. If Bob defaults, lender Larry will foreclose on borrower Bob to gain possession of the property.
Example: After the borrower defaulted on payments for three months, the lender posted the property for foreclosure.
Example: A lender foreclosed on a mortgage loan with an outstanding principal balance of $100,000 and accrued but unpaid interest of $2,000. At the foreclosure sale, the property brought $80,000. The lender claims a deficiency of $22,000 plus expenses in filing for a judgment for this remaining amount in the courts.
Example: A mortgage with payments past due for more than 10 days is considered delinquent.
Example: As a first step in estimating the demand for new or existing housing units, a real estate company may would likely undertake a demographic study, which would review the current population density and rate of growth, the age distribution of the population, and average household size in that local market area.
Depreciation allows an investor to gain a tax deduction without having to make any cash payment. It thus provides an important benefit to real estate investors. It results in an adjusted tax basis for the property; this adjusted basis will result in some additional tax at the time of sale, but the tax will have been deferred and may well be at a lesser rate than would have earlier applied.
Example: An asset purchased for $1,0000 is expected to generate annual income of $100 for the next 10 years, after which time it is expected to sell for $1,200. Discounted cash flow analysis indicates that the internal rate of return on the investment would be 11.2% annually.
Example: A potential purchaser of a property sent some experts to perform a due diligence review of the property, including a review of the mechanical and electrical systems of a building, local market conditions and competition, and environmental hazards.
Example: An investor is considering making an investment through a real estate crowdfunding company. As part of his due diligence, he carefully reads the offering materials, listens to a pre-recorded webinar in which the sponsoring company presents the opportunity, and contacts the crowdfunding company with any additional questions he may have.
E | F | G
Example: Encumbrances on Bob's land include 3 mortgages, 4 leases, a mechanic's lien, and a deed restriction preventing the sale of alcoholic beverages on the land.
Example: The benefits and risks of owning real property may vary depending on the type of entity that is formed. Among the options are:
individual ownership (see Tenancy entries)
limited liability company (LLC)
real estate investment trust
Example: The deed to the property and the purchase amount were both placed in escrow pending fulfillment of other conditions to the contract.
Example: An appraisal of a home indicates that its fair market value is $150,000. In a normally active market, the home should sell for this amount if allowed to stay on the market for a reasonable period of time. The owner might, however, give the property to a relative. He might also grow impatient and sell the house for $140,000 -- less than the price he could likely obtain if he kept the house on the market for a longer period. Conversely, an over-eager buyer might be found who would be willing to pay $160,000. If the owner were to provide unusually favorable financing, he might even be able to sell the property for $170,000.
Example: A property costing $100,000 is financed with a first mortgage of $75,000, a second mortgage of $15,000, and $10,000 in cash. If the borrower defaults and the property is sold upon foreclosure for $80,000, the holder of the first mortgage will receive the full amount of the unpaid principal plus legal expenses. The second mortgage will only receive any amounts remaining after the first mortgage has been satisfied, and in this example would not be paid back all of its principal.
Example: Many environmentally conscious people seek to buy or rent space in green buildings to feel that they are part of the solution to the world's energy and environmental problems.
Example: Gross sales price (before broker fees); gross income (before vacancy rates are factored in); gross leasable area (before subtracting common areas).
Example: The landowner, the Shawmoca Indian tribe, gives a 75-year ground lease to Josephine. Josephine pays rent of $5,000 per year and builds a store on the property. At the end of the 50-year period, however, the entire property (including the store that Josephine built) reverts (goes back to) to the Shawmoca Indian tribe.
Example: George forms a limited liability company to hold the property he expects to purchase. The lender demands that he also execute a personal guaranty for the loan that he needs to acquire the property.
H | I | J | K
Example: Hazardous substances include solid wastes that can pose a significant threat to human health and chemical contaminants. A petroleum exclusion exempts petroleum products from CERCLA.
Example: Because real estate tends to increase in value during periods of inflation, it is considered a good inflation hedge. The reason has much to do with replacement costs and the ability to pass along increased expenses in the form of rent increases.
Example: Some real estate investors prefer short hold periods (under 5 years) in an attempt to retain a high level of financial flexibility. Others hold property for longer periods, to reduce frequent transactions costs and to forestall depreciation recapture.
Example: The lender retained 20% of the amount of the rehab loan as a holdback, or reserve, until the borrower could show that the agreed renovation work had actually been completed.
Example: Institutional lenders are a prime source of real estate loans for owner-occupied properties. Some institutions, such as savings and loan associations and commercial banks, originate loans directly; others, such as insurance companies, lend through mortgage brokers.
Example: Lenders require payment of interest at a specified rate, to compensate them for risk, deferment of benefits, inflation, and administrative burden.
2. The type and extent of ownership.
Example: An investor may hold a membership interest in a limited liability company (LLC).
Example: A property was purchased with a 5-year interest-only loan of $100,000 at an 8% interest rate. The interest of $8,000 must be paid annually for four (4) years. The $100,000 principal amount, together with the last $8,000 interest payment, will be due at the end of the fifth year.
Example: John sells for $200,000 land that he bought 4 years earlier for $100,000. The internal rate of return was about 19%; that is the annual rate at which compound interest must be paid for $100,000 to become $200,000 in 4 years.
Example: Mary received $3,000 per year for 5 years on a $10,000 investment. The internal rate of return was about 15%.
Example: Jones Real Estate, Inc. forms a new legal entity that will hold title to property he wants to acquire. Investor Smith is interest in helping to finance that purchase. The new legal entity, into which Smith provides financing and that Jones uses to purchase the property, is sometimes called a joint venture.
L | M
Example: A lender issues a letter of intent to a potential borrower that states, "We would be interested in extending a mortgage loan to you to you for $100,000 at a 12% interest rate and will pursue this matter with you in the coming days. This letter of intent does not commit either party to borrow or lend."
Example: Susan is contemplating buying a rental property for $100,000, which property produces net operating income of $10,000 per year. If she purchase it with all cash, her annual rate of return is 10% ($10,000 / $100,000). If she leverages the investment by investing only $25,000 and borrowing $75,000 at 8% ($6,000 annually), her return on equity will increase to 16% ($10,000 income less $6,000 interest = $4,000; $4,000 / $25,000 = 16%)
Example: David wants to buy a home, but needs a loan to complete the purchase. David offers a lender a mortgage, which would create a lien on the property as security (collateral) for the payment of the debt.
Example: Steven buys a membership interest in a limited liability company (LLC) for $10,000. If the property owned by the LLC drops in value to less than the mortgaged loan amount, Steven can still not lose more than his initial $10,000 investment amount unless he separately agreed to provide a personal guarantee on the loan.
Example: If a property purchased through a limited partnership drops in value to less than the mortgaged loan amount, limited partners will lose only their initial investment, while a general partner will remain responsible for the balance of the loan and any other additional losses.
Example: Common stocks and U.S. savings bonds generally have good liquidity, since there is a ready public market for those securities and they are easily and quickly traded. Real estate and many types of collectibles, on the other hand, generally have poor liquidity, because the markets for those assets are less streamlined and because the sales process is typically a slower one.
Example: Susan borrows $75,000 of the total $100,000 purchase price of her home. The loan-to-value ratio is 75%.
Example: A multi-family apartment complex can expect to draw its tenants from a certain market area -- perhaps from persons working on that side of town, as opposed to persons working on the other side of town.
Example: A large super-mall has a larger market area than a smaller neighborhood shopping center. Shoppers can be expected to come from a larger regional area for the super-mall (which may contain a movie theater and large national clothing chains) than they would for a smaller neighborhood shopping center, which likely has restaurants, gyms and smaller service providers but which lacks appeal as a "destination" shopping center.
Example: A mortgage loan may have a maturity of 30 years. Periodic payments are established so that the loan principal will amortize by the maturity date.
Example: Williams Real Estate Co. plans to build an office tower for $11 million. It arranged an $8 million first mortgage and $1.5 million in mezzanine financing. A subordinated loan of $0.5 million and the company's equity investment of $1 million completed the capital structure.
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.
N | O
Example: A property produces rental income of $100,000. The various operating expenses for maintenance, insurance, property taxes, management, and utilities come to $60,000. The net operating income is $40,000.
Example: The Securities and Exchange Commission uses an individual's net worth (excluding the value of his primary residence) as one criteria of determining whether that person is an accredited investor.
Example: David purchases a property with a nonrecourse loan. If David defaults, then the lender may foreclose and acquire the property, but will not be able to seek a judgment against any other properties or assets held by David.
Example: Ellen borrows money from James so she can fix and flip a single-family residence. Ellen signs a note in order to acknowledge the debt, to promise to pay under specified terms, and to prescribe a procedure for curing any default. A mortgage will also be signed that pledges the residence to James as security for the note.
Example: Today, the Beach Hotel has 90 of its 100 rooms occupied; its occupancy rate is 90%. Conversely, its vacancy rate is 10%.
Example: Operating expenses can include:
real estate (property) taxes
hazard and liability insurance
Income such as salaries, interest payments, dividends, and many other items are considered ordinary income.
Example: The lender issued a $50,000 mortgage loan and charged a 3% origination fee ($1,500).
P | Q
Example: Ernest and Ivan own land by tenancy in common until they partition the land. Thereafter, each owns a particular tract of land, according to how the original was was divided.
Example: Adam and Bill form a partnership to buy land. The partnership owns the property, rather than Adam or Bill, but it files only information returns for tax purposes, while Adam and Bill pay personal income taxes on their share of the partnership's profits.
Example: Jones has neither time nor skills to manage the property that he wants to invest in. He forms a partnership with Smith, who is an experienced real estate syndicator and who will devote time and expertise to manage the property for profit. Jones contributes money, but not effort, so he is a passive investor.
Example: Paul borrowed $100,000 against land, thereby incurring a personal liability for the debt. Paul fails to make payments, so the lender foreclosed and sold the property for $70,000; Paul still owes 430,000, plus the lender's legal expenses, as a personal liability. The lender can seek a deficiency judgment against Paul for that remaining loan balance.
Example: Dan's real estate portfolio consisted of equity shares of three retail shopping centers, two multi-family buildings, and one self-storage facility, and also included shares of loans on a hotel and two single-family residences.
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.
Example: Aaron borrowed $100,000 last year at 6% interest on a 30-yr mortgage. If he pays the remaining principal now, in one lump sum, he will be subject to a pre-agreed 2% prepayment penalty that amounts to $2,000.
Example: Tom borrowed $200,000 under a 5-year loan agreement. The loan agreement had a prepayment penalty clause stating that Tom would have to pay 1% of the loan's principal balance if he paid it off before the end of the 5-year term. If he prepays early, he will have to pay a $2,000 prepayment penalty.
Example: Harry arranged a 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.
Example: George's home was foreclosed and sold for $25,000. Unpaid taxes and attorney's fees of $5,000 were accorded priority, and were paid in full. The rest of the sales proceeds were applied against the $20,000 first mortgage on the property. There was nothing left for the second mortgage, because it was lower in priority.
Example: The sponsor of a real estate syndication prepared a private placement to raise equity for the commercial real property being acquired. Only persons who are accredited investors are allowed into the offering, otherwise the sponsor may be required to register a public offering of the securities with the SEC.
Example: The broker prepared a pro forma statement for the prospective purchaser that showed all the expected cash flows for the property.
Example: A sponsor of a real estate syndication who wants to sell investment securities to persons who are not accredited investors or who are otherwise not sophisticated investors will likely be deemed to be making a public offering, which will be required to be registered with the Securities and Exchange Commission and state securities agencies.
Example: After closing, the title company sent the deed to the recorder to provide public record of ownership.
Example: By recording the deed from a sale of real property, the buyer is assured that all subsequent interested parties are given notice of the buyer's ownership interest in the property. Liens (such as deeds of trust or mortgages) may also be recorded.
Example: Roger obtains a mortgage loan from Hometown Savings. If Roger defaults on the loan, Hometown Savings may not only foreclose and force a sale of the mortgaged property, it may also have recourse to Roger's other assets if the sale fails to fully satisfy the amount due under the loan.
Example: Michelle has a $50,000 loan against her house, which is worth $200,000. She wants to get some cash to pay for her daughter's college education. She refinances the house with a new $150,000 loan, so that after paying $5,000 in transaction costs she will realize $95,000.
Example: Syndicator Nancy wants to sell membership interests in a limited liability company (LLC) that will own a portion of an office building. She uses Rule 506 of Regulation D to sell such interests only to accredited investors, to avoid the need of registering a public offering, thereby saving money and several months of delay.
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.
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%.
Example: The Securities and Exchange Commission must review the disclosure materials prepared in conjunction with a public offering of securities, the registration of those securities if they are to be publicly traded, and other matters. The agency does not, however, guarantee an investor against loss.
Example: Real estate serves as security for a mortgage loan; in the event of a borrower's default on the loan, the lender may sell the property to satisfy the debt.
2. An investment contract or other legal instrument (such as a stock, bond, option, future, or interest in mineral rights), whereby a person invests money in a common enterprise and is led to expect profits from the efforts of the promoter or some other third party.
Example: A membership interest in a limited liability company (LLC) is a security.
Example: Sensitivity analysis was applied to a certain income property investment. It was found that forecasting a 15% vacancy rate produced an expected internal rate of return (IRR) of 16%, vs. an 18% IRR for a 5% vacancy factor. On the other hand, varying the property's appreciation rate from 10% per year to 5% reduced the expected IRR from 20% to 4%.
Example: In many states, deeds of trust are used as mortgage-type legal documents. In these cases, foreclosure sales are handled through a trustee acting according to the law and the provisions of the deed of trust. This process is a type of statutory foreclosure.
Example: John provided the financing when he sold his land to Kathy, so that John held a first mortgage on the property. Kathy, though needed to obtain a loan to build a structure on the land (a "development loan"), and no lender would provide a development loan unless that loan had the first mortgage. Kathy approached John and offered to repay his loan within two years if, in exchange, he would allow subordination of his loan so that Kathy could obtain a development loan.
Example: A syndicate is formed using a tenancy in common. All of the investors have to the deed for the entire property to be conveyed. Each tenant may convey his or her share independently. Their contract states that none of the investors will seek to partition the property.
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.
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").
Examples: At the closing of a property's purchase or refinancing, a party (typically the buyer or borrower) must pay for appraisal fees, broker commissions, legal fees, mortgage origination fees, recording fees, and title search fees.
Example: A living trust was established by a person who wanted to give her warehouse to a trustee for the benefit of her children.
Example: Smith purchases property and finances it with a deed of trust from a lender. The title company is the trustee, holding legal title to the property pending Smith's satisfaction of the debt. Should Smith default on the loan, the trustee may sell the property to satisfy the debt.
U | V | W | X | Y | Z
Example: The lender's loan underwriter analyzed the loan submission package carefully, because she didn't want her firm to take excessive risk.
Example: Ten investors form a tenancy in common and purchase a 100-acre tract of land. Each cotenant obtains an undivided interest in the property. All decisions as to the use and disposition of the land are made collectively by all cotenants. No single cotenant may unilaterally mortgage, develop, or sell a portion of the property.
Example: In a college town, the apartment vacancy rate varied from 5% during the 9-month college term and 25% during the summer session. Overall, the average vacancy rate was 10%.
Example: Before a tract of land may be developed, the intended use must be permitted under the existing zoning classification. If the proposed use is not permitted, the developer must apply for a variance, or re-zoning, generally following a public hearing and a recommendation from the local planning commission.