|Real Estate Terms and Definitions
Break-Even Ratio Metric often used by commercial lenders to measure how
vulnerable a property is to defaulting on its debt if rental income were to decline.
Cash on Cash Return Property's cashflow in a given year divided by the total amount
of initial investment (plus any additional capital expenditures not financed). Expressed
as a percentage. Can be looked at on a Before- and After-Tax basis. This
calculation does not take in account any time value of money, so is mostly used for to
measure cashflow in the first year.
Capitalization Rate (Cap Rate) Net Operating Income (NOI) divided by the Purchase
Price or Value. Expressed as a percentage.
This is one of the most common metrics for measuring the property's performance
before taking financing into account.
A Cap Rate of 10%, for example, means that if you were to purchase that property for all
cash, you would earn 10% return on your investment.
Cumulative Cash on Cash Return Total cashflow to date divided by the total amount
of initial investment (plus any additional capital expenditures not financed).
Can be looked at on a Before- and After-Tax basis.
The point where Cumulative Cash on Cash passes 100% is the point where the
investor gets their entire investment back.
Debt Coverage Ratio Ratio between a property's Net Operating Income (NOI) for the
year and the annual debt service (total mortgage payments). This is a metric often used
by lenders to measure whether the property will generate sufficient cashflow to cover
it's mortgage payments.
Depreciable Basis The portion of the property's value that can be depreciated.
Usually equals to Purchase Price minus Value of Land plus any Capital Improvements
minus Depreciation already taken.
Discount Rate Conceptually, the discount rate can be thought of as a required
return for a real estate investment based on its risk when compared with return earned
on competing investments.
One way to calculate such rate is to add a risk premium and a liquidity premium,
corresponding to the property, to a relatively risk-free rate such as a US Treasury bill.
This rate will be used to discount the property's expected cashflows to arrive at their
Effective Mortgage Rate Blended mortgage rate adjusted for leverage. If you are
borrowing at 80% LTV, for example, with a rate of 10%, your effective mortgage rate is
A quick and useful performance measure is to subtract your effective mortgage rate
from the Cap Rate. If the result is positive, you should expect positive cashflow.
Gain on Sale Selling Price minus Adjusted Basis. This is the taxable profit that's
made when an income-producing property is sold.
Gross Operating Income Gross Scheduled Income minus Vacancy allowance.
Gross Scheduled Income Total annual rent value of all units in the property. This
figure represents the total rent that the property would generate given 0% vacancy.
Gross Operating Expenses All the expenses that are required to keep the property
cashflowing. Does not include capital improvements or mortgage payments.
Gross Rent Multiplier Market Value divided by Annual Gross Scheduled Income. At
time of purchase, market value can be computed as purchase price plus any initial
Internal Rate of Return (IRR). Also viewed as a discount rate at which the net
present value of an investment is zero.
This metric takes into account both the timing and the magnitude of future cashflows
produced by the property
Leveraged IRR This is the Internal Rate of Return on your investment. It measures
the cashflow received in the future vs the Total Cash Outlay at time of purchase.
It's called "Leveraged IRR" because it measures the return on your cash investment, not
the property. Depending upon Leverage, your investment may be big or small.
IRR gives you the rate, which if used as a Discount Rate, would produce an NPV of zero.
If your IRR result is greater than your discount rate, then the proposed investment will
yield a positive NPV, and vice versa.
Loan-to-Value Ratio (LTV) Total debt outstanding divided by market value of
property. At the time of purchase, this is usually the loan amount divided by the
Modified Internal Rate of Return (MIRR) In certain cases, IRR tends to overstate the
true rate of return. The IRR measure assumes that every cashflow received over time
by investor is reinvested at the internal rate of return. So for example, if you have an IRR
of 20% at the end of year 15%, the calculation assumes that each cashflow receinved in
years 1-14 is reinvested at 20%. In reality, this may or may not be the case, since it may
be tough to constantly find other investments that yield 20%.
For that reason, it's prudent to also use the MIRR measure. This calculation allows you
to specify the cost of your capital as well as the reinvestment rate
you expect to achieve when investing the cashflows from the property.
Note that for certain under-performing investments, MIRR will actually be higher than
IRR, if you reinvest the cashflows at a higher rate than the IRR.
Net Operating Income (NOI) Gross Operating Income minus Gross Operating
Expenses. This is the gauge of performance of the property before taking financing and
depreciation into account.
Net Present Value of Property Purchase Price of Property subtracted from the PV of
Property. If the NPV is positive, your Required Rate of Return will be achieved.
Net Present Value of Investment Initial Capital Investment subtracted from the PV
of Investment. If the NPV is positive, your Required Rate of Return will be achieved.
Payback Period The amount of time it will take, in years, to return your initial
investment. * This is based on the 1st year (projected) pre-tax cashflow, and thus
though, is a good way to compare similar properties to each other.
Pre-Tax Leveraged IRR Measures pre-tax cashflows produced by the property
versus your initial investment.
This figure does not take into the account the cash proceeds of a sale, and is most
relevant when used to analyze a buy and hold investment with a time horizon longer
than 20 years.
Present Value of Property Future NOI produced by the property, discounted back at
the Required Rate of Return.
If the required rate of return is equal to the buy-in Cap Rate, and NOI is expected to
remain stable, PV of property will equal the Purchase Price.
If you expect growth in NOI, PV of property will be higher than purchase price, meaning
that your Required Rate of Return will be exceeded.
Present Value of Investment Future after-tax cashflows produced by the property,
including the cash proceeds of sale/disposition, discounted back at the Required Rate
Return on Equity (ROE) Total After-Tax Cashflow received in a given period divided
by the current amount of equity in the property.
This is sometimes used in order to determine whether to hold or sell the property. If the
equity in property grows at a faster pace than the cashflow, the ROE will diminish with
each passing year. At some point, the existing equity in the property will no longer earn
your required rate of return, even though the dollar amount of cashflow may be quiet
large and growing.
At that point, it may be worthwhile to either refi or sell the property, and invest the equity
into a better-yielding project.