Due Diligence refers to the practice of investigating or auditing a prospective investment in order to confirm facts. The audit includes analyzing different aspects of the investment like reviewing financial records, going over all legal documentation, etc. Due diligence is effectively the care any reasonable party should take before entering into any legal agreement or financial transaction
Compound Interest, sometimes called "compounding interest", is when interest is added to the principal amount after each period, and the next recurring interest calculation includes the principal along with the accumulated interest. Because of this, Compound interest is often referred to as "interest on interest". As opposed to simple interest, where interest is only calculated using the principal, compound interest can make a sum grow exponentially.
Recourse debt, also referred to as a recourse loan refers to a debt where the lender is able to claim the borrower’s assets if he or she fails to pay back the debt to its full amount. Unlike recourse debt, with non-recourse loans the lender is only allowed to collect the collateral but has no right to go after the borrower’s other personal assets.
Commercial mortgage rates are influenced by the U.S. Treasury yields, where lower treasury yields lead to lower mortgage rates. This results in larger homes at a more affordable price and ultimately, in economic growth. However, a rise in the U.S. Treasury yields means the mortgage rates will also increase in order to compensate for the high risk.
Mezzanine Financing in commercial real estate authorizes a lender to convert a debt into equity in the event that a borrower defaults. For example, if the borrower fails to pay the debt in a timely manner, the lender has the right to take action by taking a portion of the investment property and then selling it to pay off that debt.
A Gross lease is a type of lease wherein the landlord pays the property taxes, insurance, and maintenance (CAM). The tenant is only responsible for paying a flat fee as rent, the landlord will be responsible for all costs related to property ownership. When determining the rent, the landowner accounts for all the anticipated costs for the property and charges a flat fee that will cover the costs and cater to the required profit margin.
An interest rate cap is used to limit the risk on a floating rate commercial property loan. A floating rate property loan has a variable interest rate, borrowers usually opt for this type of loan during periods of low-interest rates, because if the interest rate decreases further than the borrower benefits. A floating interest rate can also increase and that may be a huge financial risk if it increases rapidly or by too much. For this reason, borrowers try to cap the amount by which interest on the loan increases.
A lockout is a restriction within the commercial real estate loan to prevent prepayment of the loan. If the loan is paid early then the lender will not benefit from the anticipated yield of the loan. For this reason, some commercial real estate loans will have a lockout period, which would be the minimum number of years in which the borrower cannot pay off the entire loan.
The modified gross lease, also sometimes referred to as the modified net lease, is a combination of the gross lease and the net lease. The operating expenses are both the landlord and tenant's responsibility. A modified gross lease falls in between the spectrum of a net lease (where the tenant is responsible for the operating expenses) and a gross lease (where the landlord is responsible for the operating expense).
Net Operating Income (NOI), is the net income generated by a property after deducting operating expenses. The NOI measures the ability of a property to generate income from operations as a single project. The NOI only accounts for the property in question and no other operations.
An earn out is an agreement by the lender to increase the loan amount at the advent of a certain event. Earn outs are structured such that the additional money can be handled by the operating performance of the property. For example, more money can be released in the form of an earn out if the property has gone through renovations, has upgraded its tenant’s minimum income criteria or increased its tenant occupancy.
A holdback is a clause in the commercial property loan that seeks to put aside a certain portion of the loan until an objective has been accomplished. Holdbacks account for any issue that has not been resolved before closing the contract and can be solved soon after. The holdback is held in the lender’s escrow account.
Capital expenditure or "CapEx" are the funds used to acquire, upgrade or repair the property . It also includes the acquisition of equipment for said property. An expenditure is considered a CapEx if it is a new purchase or extends the life of the property. For example, fixing the roof, installing a furnace or painting the building.
Common Area Maintenance or "CAM" fees are charges incurred in a commercial lease. CAM is paid by a tenant to their landlord. CAM is charged on top of the basic rent and caters for maintenance expenses incurred for work on the common area of a property. For example, in an office park, the tenants will pay CAM for the gardening on the office park.