Glossary
Plain-English definitions of the terms you will meet in multifamily syndication, from cap rates and debt coverage to waterfalls, K-1s and Rule 506(c).
Definitions describe how terms are generally used in the industry, not the terms of any offering. Tax entries are general information, not tax advice; consult a tax adviser about your situation.
1
- 1031 exchange
A provision of the US tax code (Section 1031) that can let an owner defer tax on the gain from selling investment real estate by reinvesting the proceeds in other like-kind real estate within strict deadlines. Interests in a partnership generally do not qualify on their own, so whether an exchange is available depends on how the property is held. Consult a tax adviser.
A
- Absorption
The pace at which available apartments in a market are leased over a period, usually measured as the net change in occupied units. Absorption that keeps up with new supply points to healthy demand.
- Accredited investor
A person or entity that meets the SEC's income, net worth or professional criteria in Rule 501(a) of Regulation D, and so may invest in certain private offerings.
- Agency debt
Multifamily loans made under Fannie Mae and Freddie Mac programs. They are typically long-term, non-recourse apart from standard exceptions, and meant for stabilized properties, and they often carry prepayment terms that make paying the loan off early costly.
- Amortization
Repaying a loan's principal through regular payments over a set schedule. A loan can amortize over 30 years yet mature sooner, in which case the remaining balance is due at maturity.
B
- Bonus depreciation
A federal tax provision that can let a large share of the cost of qualifying shorter-lived property, such as items identified in a cost segregation study, be deducted in the year it is placed in service. The percentage allowed has changed over time with tax law. Consult a tax adviser.
- Bridge loan
Short-term financing, usually floating-rate and often interest-only, used to buy and reposition a property before it qualifies for long-term debt. It is normally repaid by a refinance or a sale.
C
- Capital call
A request for investors to contribute money beyond their original investment, for example to cover an unexpected cost. Whether a capital call is allowed, and what happens if an investor does not fund it, is set by the operating agreement.
- Capital expenditures (CapEx)
Spending that extends a property's life or adds value, such as roofs, mechanical systems or unit renovations. CapEx is generally kept out of operating expenses, and so out of NOI.
- Capital stack
The layers of money used to buy a property, ranked by who is repaid first: senior debt at the bottom, then any mezzanine debt or preferred equity, then common equity at the top. Higher layers carry more risk and more potential reward.
- Capitalization rate (cap rate)
A property's net operating income divided by its value or purchase price. It describes the unlevered yield a buyer is paying for, and is often used to compare properties and markets.
- Cash flow before tax
Net operating income less debt service and, depending on the convention used, capital reserves. It is the cash available to the owners before income taxes.
- Cash-on-cash return
A year's pre-tax cash flow divided by the equity invested, shown as a percentage. It measures current yield on the cash put in and ignores appreciation and the timing of a sale.
- Class A, B and C properties
An informal grading of apartment properties by age, quality, amenities and location. Class A is typically newer and highest-end, Class B older but well kept, and Class C older and in need of more capital and management attention. The lines vary by market.
- Closing costs
One-time costs of completing a purchase, such as lender fees, title insurance, legal fees, transfer taxes and third-party reports. They add to the equity needed at closing.
- Concessions
Incentives used to attract or keep tenants, such as a free month of rent or a reduced deposit. They lower the rent actually collected compared with the rent stated on the lease.
- Cost segregation
An engineering-based study that identifies parts of a property, such as fixtures, finishes and site improvements, that can be depreciated over shorter lives (typically 5, 7 or 15 years) than the building itself. It can bring depreciation deductions forward. Consult a tax adviser.
D
- Debt service
The scheduled principal and interest payments on a loan over a period, usually stated per year.
- Debt service coverage ratio (DSCR)
Net operating income divided by annual debt service. Above 1.00x, the property's income covers its loan payments. Lenders set a minimum ratio as a condition of the loan.
- Debt yield
Net operating income divided by the loan amount. Lenders use it as a measure of risk that does not depend on the interest rate or the amortization schedule.
- Depreciation
A non-cash tax deduction that spreads the cost of a building, but not the land, over its useful life: 27.5 years for residential rental property under current US rules. It can offset taxable income from the property and may be recaptured when the property is sold. Consult a tax adviser.
- Distributions
Cash paid by the investment entity to its investors, typically from operating cash flow, a refinance or a sale. Distributions are not guaranteed; their order and timing are set by the operating agreement.
E
- Economic occupancy
The share of a property's gross potential rent that is actually collected, after vacancy, concessions, bad debt and loss to lease. It is usually lower than physical occupancy.
- Effective gross income (EGI)
Gross potential rent plus other income, less vacancy, concessions and credit loss. It is the income a property expects to collect before operating expenses.
- Equity multiple
Total cash distributed to an investor over the life of an investment divided by the cash invested. A 2.0x multiple means distributions totalled twice the original investment; it says nothing about how long that took.
- Exit cap rate
The cap rate assumed when estimating a property's sale price at the end of the hold period. Underwriting often assumes an exit cap rate above the purchase cap rate as a cushion.
F
- Forced appreciation
An increase in a property's value that comes from the owner's own actions, such as raising net operating income through renovations, better management or lower expenses, as opposed to a rise in the overall market. Because value is commonly tied to net operating income, a higher income can support a higher value, but results depend on the property and the market.
G
- General partner (GP)
The sponsor side of a syndication: the party that finds, finances and manages the investment and makes its decisions. In an LLC the equivalent role is usually called the manager or managing member.
- Gross potential rent (GPR)
The rent a property would collect in a year if every unit were leased at market rent, with no vacancy or concessions. It is the starting line for most income projections.
H
- Hold period
How long a property is expected to be owned, from purchase to sale. A business plan states an expected hold, but actual timing depends on markets, financing and the sponsor's judgment.
I
- Interest-only period
A stretch at the start of a loan when payments cover interest only, with no principal repaid. Debt service is lower during that stretch and rises once amortization begins.
- Internal rate of return (IRR)
The annualized return that accounts for the size and the timing of every cash flow into and out of an investment. Money returned sooner raises IRR more than the same amount returned later.
K
- K-1 (Schedule K-1)
The tax form a partnership, including an LLC taxed as one, issues to each investor every year, reporting that investor's share of income, losses, deductions and credits. Investors use it to prepare their own returns, and it can arrive later than other tax forms.
- KYC and AML
Know-your-customer and anti-money-laundering checks: confirming an investor's identity and the source of funds before an investment is accepted.
L
- Limited partner (LP)
A passive investor in a syndication who contributes capital, takes no part in day-to-day management, and whose liability is generally limited to the amount invested. In an LLC limited partners are usually called members.
- Loan-to-cost (LTC)
The loan amount divided by the total project cost, including the purchase price, closing costs and planned improvements. It is common in value-add and construction lending.
- Loan-to-value (LTV)
The loan amount divided by the property's appraised value or purchase price. At 70% LTV, debt funds 70% of the value and equity the remaining 30%.
- Loss to lease
The gap between market rent and the rent tenants actually pay under their current leases. Closing it as leases renew is a common source of income growth.
M
- Metropolitan statistical area (MSA)
A region defined by the US government, made up of a core city and the surrounding counties economically tied to it. Rent, employment and population data are often reported by MSA.
N
- Net operating income (NOI)
A property's income after operating expenses, before debt service, capital expenditures, depreciation and income taxes.
O
- Operating agreement
The governing document of an LLC. In a syndication it sets out the duties of the manager and the rights of investors, including distributions, fees, voting and what happens on a sale or a capital call.
- Operating expense ratio (OER)
Operating expenses divided by effective gross income. It shows how much of each dollar collected goes to running the property, and varies widely with a property's age, size, location and who pays utilities.
P
- Passive activity loss
A loss from a trade or business in which the taxpayer does not materially participate, or from most rental activity regardless of participation. Passive losses can generally offset only passive income, with unused losses carried forward; exceptions apply. Consult a tax adviser.
- Physical occupancy
The percentage of units occupied at a point in time, whether or not every tenant is paying rent in full.
- Preferred return
A threshold return, usually an annual percentage of contributed capital, that investors receive before the sponsor shares in profits. It sets an order of payment; it is not a guarantee that the return will be paid.
- Private placement memorandum (PPM)
The disclosure document for a private offering. It describes the investment, the business plan, the fees, the risks and the terms of the securities offered.
- Pro forma
A projection of a property's future income, expenses and cash flow built on stated assumptions. It is an estimate, not a promise of results.
- Promote (carried interest)
The share of profits a sponsor receives beyond its share of invested capital, usually after investors receive their preferred return. It ties the sponsor's pay to how the investment performs.
R
- Rate cap
An interest rate cap: a contract, usually required with floating-rate loans, that pays the borrower when the benchmark rate rises above a set level, limiting the borrower's interest cost for its term.
- Refinance
Replacing a property's loan with a new one, for example to change the rate or term or, once the property's value has grown, to return part of investors' capital.
- Regulation D
SEC rules that let companies raise capital through private offerings without registering the securities. Rules 506(b) and 506(c) are the provisions real estate syndications use most.
- Rent roll
A schedule of every unit at a property with its status, lease dates, rent and deposit. Buyers check it against bank deposits and the T-12 during due diligence.
- Reserves
Cash set aside, at closing or from operations, for future capital needs or unexpected shortfalls. Lenders may require replacement reserves, and sponsors often hold operating reserves as well.
- Rule 506(b)
A Regulation D exemption that allows an unlimited amount to be raised from accredited investors and up to 35 non-accredited but financially sophisticated investors, without general solicitation or advertising.
- Rule 506(c)
A Regulation D exemption that permits general solicitation and advertising, provided every investor is accredited and the issuer takes reasonable steps to verify that status.
S
- Sensitivity analysis
Testing how projected results change when key assumptions change, such as rents, occupancy, interest rates or the exit cap rate. It shows which assumptions a deal depends on most.
- Sponsor
The person or firm that organizes a syndication: it finds the property, arranges the financing, raises the equity and runs the business plan. Often used interchangeably with general partner.
- Stabilization
The point at which a property reaches its expected long-term occupancy and income, typically after a lease-up or renovation period. Many long-term loans require a stabilized property.
- Subscription agreement
The contract an investor signs to buy into an offering. It records the amount invested, confirms the investor's eligibility and acknowledges the risks described in the offering documents.
T
- T-12 (trailing twelve months)
A property's income and expense statement for the most recent twelve months. It shows actual recent performance and is the usual starting point for underwriting.
U
- Underwriting
The analysis used to evaluate a property and decide what to pay for it: reviewing its financials, market, physical condition and financing, and building projections on stated assumptions.
V
- Value-add
A strategy of buying a property with room to raise its income, for example by renovating units, improving management or cutting expenses, and so increase its value.
W
- Waterfall
The order in which cash from operations, a refinance or a sale is split between investors and the sponsor: typically return of capital and the preferred return first, then profit splits at one or more tiers.
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