So We know that not everybody wants to ask us to explain certain terms that they hear us talk about in multifamily, but don’t understand. Based on a little feedback that we got We found some common terms that people don’t always understand in our industry. We thought We would do a little bit of ‘esplanin!
1-Accredited investor-
In the United States, to be considered an accredited investor, you have a net worth of at least $1,000,000, excluding the value of primary residence, or have income at least $200,000 each year for the last two years (or $300,000 combined income if married) and have the expectation to make the same amount in the future.
2-Sophisticated investors,
Based on the SEC’s definition, have enough knowledge and experience in business matters to evaluate the risks and merits of an investment. The SEC exempts small companies from registering certain securities sold to these investors. (Regulation D 506b we can have up to 35 of these individuals).
3-Gross rent multiplier-
GRM is a way of quickly valuing an asset based on gross rents or determining gross rents based on prices. GRM = Price / Gross Rents. Also can think of it as number of years it would take for gross rents to pay for property based on today’s purchase price.
4-Ppm- private placement memorandum-this is the holy Grail of what risks you’re about to enter into for an investment. Ppm is used across the commercial real estate industry.l and other industries. Some commercial buildings, developments, apartment investments and more are using this set of documents to show investors what risks could be associated with their investment. A PPM is often seen in groups who are syndicating or pooling money together. This is usually in a syndication.
5-Cap rate- or capitalization rate is the ratio between net operating income produced by the asset and the original capital cost. Also known as the current market value. there is a going in cap rate and an exit cap rate. Entry cap rate is based the current performance of the asset (and should closely be related to market average of cap rates) at the purchase. The exit cap rate is the adjusted cap rate when you will sell the property. This is often a controversial topic. Exit cap rate we always use higher cap rate numbers (we assume it is less stabilized at sale than purchase, showing asset performance in a recession or major problem when we MUST sell) to account for any performance issues in the economy. This is considered conservative to increase the exit cap rate from entry 75-200 basis points or less stable than when we bought it. The variance in basis point adjustment at sale heavily depends on that current market condition. But for an area like DFW- there is a level of stability and therefore less of a cap rate increase on sale. (You can get a higher price regardless).
Formula for this is:
NOI/cap rate=market value or sales price
6-Basis points-one hundredth of one percent (50 basis points =.50 rate point adjustment)
7-Debt Yield-
One of the most important risk metrics in multifamily loans.I didn’t know what debt yield was till I did bridge loans and how it goes into factoring risk for the lender. It is the NOI/ total loan amount. Lenders use this to determine how long it would take them to recoup their investment if it had to go back to the bank. Many lenders require a minimum debt yield in order to approve a loan, so it’s possible to calculate the maximum loan amount, as long as you know the annual income of a property. They want to see a five going in and higher than 8 after stabilized.
8/9-CAPEX (CAPITAL EXPENDITURES)
VERSUS MAINTENANCE? What’s the difference?
CAPITAL EXPENDITURES ARE MEANT FOR IMPROVING THE VALUE OF THE ASSET AND ARE BELOW THE LINE EXPENSES IN YOUR PROFIT AND LOSS STATEMENT. MEANING CAPEX IS DEDUCTIBLE FROM YOUR TAXES DIFFERENTLY THAN MAINTENANCE COST.. IT GENERALLY IS RECOVERED THROUGH DEPRECIATION..MAINTENANCE IS A REGULAR SCHEDULED COST OF MAINTAINING THE ASSET IN THEIR ORIGINAL CONDITION-LIKE FILTERS, LIGHTBULBS, TOILET REPAIRS, ETC.. WE BUDGET MAINT COST AS AN AVERAGE PER UNIT WHERE CAPEX IS BASED ON LARGE RENOVATION PROJECTS PLANNED FOR IN DETAIL/IN BUSINESS PLAN.
10-Bridge loans-Bridge loans bridge the gap between the time when the Multifamily owner gets the loan for the property and does what they want to do with the property. Super. Ague I know. Many uses. Multifamily and commercial real estate bridge loan terms are typically 3 months -3 years. It’s best to use when all cash is not an option. Because it requires a far less rigorous analysis for the loan the closing time period Is much shorter. there’s a trade off here as interest rates or sometimes double or triple what a conventional loan would be. Bridge loans can be used for substantial rehab of a multi family property and then financed into conventional Multifamily financing.
11-Skin in the game-
How much of the sponsors money is in the deal.
12-LIHTC
LIHTC (Low-Income Housing Tax Credits) – we do not do rent control like this
13-CMBS –
Commercial mortgage back security. The loan is pooled with other loans then sold off to investors for a return. These are also known as conduit loans, These are long term nonrecourse loans however they come with a hefty prepayment penalty named yield maintenance and defeasance in our industry. This is to protect the return that the pooled investors expect.
14-Subscription agreement-
It’s the contract investors get before investing which is an agreement that the investor understands the PPM and has read it fully, they understand what they are purchasing, how they would like to receive payment of distributions and profits, they agree to purchase and tinder purchase money with the subscription agreement (wire funds within a certain timeframe).
15-Investor suitability-
One of the forms filled out before investment in a private placement. This form is a self-certification Of whether the investor is sophisticated, accredited or neither. this must be filled out prior to investment, and prior to any wiring of money. It is required by the SEC.
16-Cost segregation-
In the USA tax laws/accounting rules this is the process of removing personal property assets from real property assets. It’s used as a strategic tax planning tool Which allows companies or individuals who have purchased, rehabbed, remodeled, expanded any kind of real estate to improve cashflow by accelerating depreciation deductions and deferring state and federal income taxes.
17-Bonus depreciation-
A business Incentive that allows for A business to immediately deduct a large portion if not close to 100% of its Purchase price of eligible assets in the first year of purchase. This came from the tax cuts and jobs act. It’s known as the additional first year depreciation deduction.
18-IRR-
The return term internal refers to the fact that the calculation excludes external factors, such as inflation, the cost of money/capital, and other financial risks.
In simple terms it is The interest rate at which the net present value of all cash flows, including positive and negative, equal zero.
The initial cost of the project is used and estimates of the future cash flows to figure out the interest rate.
We use a computer- but you can figure out internal rate of return through trial and error — plug different interest rates into Your formulas until you figure out which interest rate delivers an NPV closest to zero.
Really a project with positive NPV will also have IRR that exceeds the cost of capital. AKA thumbs up.
The rule-business’ should not accept projects with IRR that exceeds the cost of capital.
