In commercial real estate, pari passu simply means that two investors, creditors, or assets are on equal footing— that is, without preference to one or the other. Pari passu is most commonly used to describe the way that CRE investors receive payouts, especially when waterfall structures are being used. It’s also sometimes used to indicate that two creditors or investors have an equal claim on a borrower’s assets, especially in the case of a borrower default.
Residual land value is a metric that equals the value of the land, after all costs of developing have been subtracted. For example, if an investor purchased land for $500,000 and spent $1 million building an office park, which they then sold for $2 million, the residual value of the land would be $500,000.
Most commercial real estate loan interest rates are currently set by using the LIBOR (London Interbank Offered Rate) as a benchmark. LIBOR is calculated by measuring the interest rates at which banks lend to each other (specifically short-term, unsecured lending). However, due to a variety of reasons, banks are set to stop reporting LIBOR rates in 2021. SOFR (Secured Overnight Financing Rate) is the index set to replace it— but how will this affect commercial real estate lending? Let’s take a look.
Loss to lease is one of the most essential metrics in multifamily real estate, and can be defined as the difference between actual rent and market rent. In general, this income is lost by offering incentives to encourage tenants to sign a lease. For accounting purposes, loss to lease is generally recorded as a separate line on an accounting balance sheet.
In most commercial leases, rents are set to increase over time. How often, and by how much they increase is specified in a lease contract’s rent escalation clause. Rent escalation clauses are essential for commercial landlords, since, if rents did not increase, landlords would not be able to keep pace with inflation. In practice, this means they likely be unable to continue renting their properties due increase maintenance and operating costs.
The Historic Tax Credit, or HTC program, is a 20% federal tax credit designed to encourage investors to fund the substantial rehabilitation of historic structures. Since 1976, Historic Tax Credits have bee responsible for creating $144.6 billion in private investment in historic building rehabilitation while preserving more than 43,000 historic structures across the country. With the credit, an investor can take 20% of the Qualified Rehabilitation Expenditures (QREs) of the project as a deduction from their federal income taxes.
The New Markets Tax Credit (NMTC) is a federal tax incentive program designed to encourage investment in low-income communities. Since congress started allocating credits in 2003, the program has issued approximately $25 billion in tax credits. Specialized investment vehicles called community development entities (CDEs) compete for NMTCs, which are allocated by the U.S. Department of the Treasury. Once a CDE has been allocated NMTCs, they can award investors the tax credits. In order to qualify for NMTCs, a CDE needs to invest or provide loans to a business located in one of approximately 31,000 qualified low-income census tracts.
Opportunity Zones are economically disadvantaged census tracts across the United States in which investors can gain tax benefits by investing in eligible properties and businesses. Right now, there are 8,700 Qualified Opportunity Zones (QOZs) across the country. To gain the tax benefits of the Opportunity Zones program, an investor must invest in an Opportunity Fund, a special investment vehicle which needs to hold at least 90% of its assets in eligible property or businesses located inside an Opportunity Zone.
Net effective rent is a calculation of average monthly rental cost that incorporates landlord rental concessions, typically a free month of rent. For example, if an apartment was being advertised with a net effective rent of $1500/month for a 12-month lease with one month of free rent, it might actually have a monthly rent of $1625. However, if you take the entire rent paid over the 13-month period, it actually has an average, or “net effective” rent of $1500/month.
A ground lease is a type of long-term lease agreement that allows the tenant to build on and make significant improvements to the leased property. Ground leases usually last between 50-99 years, and generally stipulate that the property and all improvements made during the lease will revert to the landlord after the termination of the lease.
Effective gross income (EGI), is all the income generated by a property, including rent, tenant reimbursements, and income from sources such as vending machines and laundry machines. It can also be defined as a property’s potential gross income, after expenses such as vacancies and credit costs have been subtracted. EGI is an efficient way to estimate a property’s value and cash flow
A lease assignment occurs when a tenant fully transfers their lease to another party. This is particularly important for tenants who wish to get out of their leases early due to financial issues, especially if a landlord does not allow subleases. In general, the landlord must agree to the lease transfer, and usually records their consent to it via a document called a “license to assign.”
A multiple listing service, or MLS, is a software system used by real estate brokers in order to represent the sellers of properties, search for properties for buyers, and to establish commission rates for other brokers who may help a broker sell a property. There are approximately 900 MLS services in the United States, most of which are intended for residential property brokers in specific local areas. However, there are only a few commercial MLS providers that stand out, including LoopNet, CoStar, CREXi, Brevitas, and ApartmentBuildings.com.
If you need capital to make repairs or renovations to your commercial property, or you’d like additional funds to purchase a new investment property, you may want to take out a commercial equity loan. Commercial equity loans allow you to tap into the equity you’ve built up in a property in order to get cash. These loans are typically offered by banks, but can be offered by private lenders. Commercial equity financing is also ideal for business owners that need additional funds to pay bills or expand their business.
Unless you plan to manage a commercial property yourself, hiring a commercial property management company is a must for any serious commercial real estate investor. However, just like any service, property management costs money. Typically, a commercial property management fee will be between 4-12% of the rent for a commercial property, though this can vary greatly upon several factors, including the location, size and condition of the property, the amount, type, and quality of tenants, the specific services that the company is expected to perform, and the average property management rates for that area.
Refinancing commercial real estate can be done for a variety of reasons. In many cases, borrowers get cash out refinances in order to free up capital to make renovations/property improvements, or to invest in other properties. In other situations, borrowers may wish to refinance a commercial property in order to achieve a better interest rate or a longer amortization, which can help them increase monthly cash flow.
Commercial leases can last as little as a few months, or as long as 20 years or more. In contrast, multifamily apartment leases are typically 12 months, with some leases ranging as long as 24 months. However, before a lease is up, a landlord has the option of allowing a tenant to renew their lease. Whether they want a tenant to renew is up to several factors, including the tenants behavior, as well as individual factors involving the property.
Securitization is the process in which commercial or residential real estate loans are pooled together, packaged into a financial product, and sold to investors on the secondary market. Not all types of commercial real estate loans are securitized, but many are. For instance, CMBS and conduit loans are always securitized and sold as commercial mortgage backed securities. In contrast, many, but not all HUD multifamily loans and Fannie Mae/Freddie Mac multifamily loans are securitized.
Debt Coverage Ratio (DCR), is a measurement of a property’s net operating income divided by its debt service. A property’s Debt Coverage Ratio, which is also known as its Debt Service Coverage Ratio (DSCR), is one of the most important eligibility factors for commercial real estate loans. Keep in mind that net operating income can be calculated by subtracting a property’s gross revenue by its operating expenses. DCR/DSCR can also be applied to an entire company, as well as a single property, which is more relevant in the case of owner-occupied commercial properties.