Financial Definitions
The following are the most commonly used phrases in real estate investment. 

Appreciation – properties usually appreciate in value each year, depending upon supply, demand, and the rate of inflation. 

Arranger -- in a Securitization transaction, the one that sets up the deal, typically an investment banker 

Cap Rate: Capitalization Rate is a ratio that gives you an idea of the value of property. It is the net operating income divided by the sales price. Operating income is a function of reducing expenses from the gross income. If you are buying a going concern with existing rental income, this ratio can help you determine if the asking price is reasonable for the income you could receive. 

Cash flow – the difference between rents you collect and the expenses that you pay for is your cash flow.  Cash flow excludes non-cash expenses such as depreciation.    

Capital Gains Treatment – Primary Residence -- Under the current tax rules, you can sell a principal residence once every two years and exclude up to $250,000 (or $500,000 for a married couple) of the gain from taxes. As long as you reside in any subsequent homes for the minimum two years, you can exclude the same amounts from capital gains taxes when you sell that principal residence. 

Credit Rating Agencies -- In Mortgage Backed Securities and other Securitization transactions, Credit Rating rate the securities created in the securitization transaction. In doing so, they provide an external perspective on the liabilities being created and help the investor make a more informed decision. 

Commercial Paper --  is a broad term that described money market securities issued by banks and large corporations to raise cash for short-term needs, typically 30 days to nine months.  The paper is secured by collateral such as stocks or a portfolio of home loans, with interest rates typically lower than bank loans.  The paper does not need to be registered with the SEC.  During times of financial turbulence the commercial paper market may dry up and non-banks may not be able to fund loans at closing.  In general, commercial paper issued by Bank holding companies are not guaranteed by the government.     

Conduit Lender -- Lenders that fund mortgages that will be later placed in Commercial Mortgage Backed Securities

Cost Recovery (Depreciation) – A fundamental of accounting is to try to match the expense of an asset to the income that the asset helps generate.  Cost Recovery (formerly called Depreciation) is a non-cash expense that may be used to reduce taxable income to account for the fact that the asset wears out or becomes obsolete over time.  There are several different methods that can be used to recover the cost of an asset as it wears out over its useful life.  The IRS regulations allow for the depreciation of most types of property (except land), Residential rental real estate has a 27.5 year recovery period, and nonresidential real estate typically has a 39 year recovery period.  Personal property is not listed in a specific asset class or identified with a specific industry it is assigned a 7 year recovery period.  Additional information can be found in a description of Modified Accelerated Cost Recovery System (MACRS).    

Debt Service Coverage Ratio -- for income producing properties, it is the ratio of the collateral property's monthly loan payment to is net operating income (rental revenues less operating costs).  Also called debt-coverage, DCR, or DSC.   DCR is usually one of the key qualifiers for determining whether a loan qualifies in a securitized program.   

Discount Window --  is a term used to describe a mechanism that allows banks and other eligible institutions to borrow money on a short-term basis, to meet temporary shortages of liquidity. The interest rate charged, called the Discount Rate, is set by the Federal Reserve and is an important tool in controlling the nation's money supply (the Federal Funds Rate is the other rate used by the Fed for affecting monetary policy.)    

Equity – the difference between the value of your property and the mortgage (loan) on the property.  Over time, the equity in your property increases as you pay off your mortgage. 

Federal Funds Rate -- The rate banks and other depository institutions loan to each other on overnight loans.  Banks and other depository institutions are required by law to keep a percentage (Reserve Requirements, usually about 10%) of the value of their demand accounts in non-interest bearing accounts with the Federal Reserve.   Banks with excess reserves may loan banks short of reserves money from their Federal Funds, usually overnight, at the Federal Funds Rate.  

Financial Guarantor -- In Mortgage Backed Securities and other Securitization transactions, in some cases, provides guarantees or partial guarantees for the assets, the principle and the interest payments, for a fee. In real estate MBS, Fannie Mae, Freddie Mac and Ginnie Mae provide guarantees.  

Government-Sponsored Enterprise (GSE) -- Federally chartered financial service corporations created by Congress to enhance the flow of credit to make the capital markets more efficient.  The three mortgage finance GSEs are Fannie Mae, Freddie Mac and the 12 Federal Home Loan Banks.  Ginnie Mae is not considered a GSE, as it is actually owned by the Government.  The mortgage corporations purchase loans from many single-family and multifamily loan originators, securitize them and sell bonds in the secondary mortgage market.  

Gross Rent Multiplier: This is a calculation that measures value in a different way that Cap Rate. It does not take into consideration the operating expenses. It is more a measurement of potential income and desirability of the area. It is probably the first estimate that you will want to do before refining you property search. If a property is being mismanaged, or the seller was not willing to bring it to a standard that would bring full occupancy, this is a good measure to look to for future value. By taking the sales price divided by full income we have a number that we can now use to evaluate the real selling price. It is not a substitute for more comprehensive data.

Interest-rate Spread -- the difference between between a securitized loan portfolio's benchmark "index" and the actual rate borrowers are willing to pay, representing default risk.  The index typically used for apartment loans is US Treasury.  The index used for Floating-interest loans is usually Libor (London Interbank Offered Rate) 

Leverage --  The ratio of the initial principal balance of a loan to the appraised value of the underlying collateral. Also called Loan-to-Value ratio or LTV, a maximum LTV is usually one of the key qualifiers for determining whether a loan qualifies in a securitized program.   When you are starting out with you first purchases, your potential net worth can be enhanced by financing versus paying cash for your first property. For instance, If you pay $50,000 cash for your first property, your gross first year income based on $775 per month rent is $9300. If you used leverage via a 10% down mortgage and with closing cost included bought seven properties, based on a gross rent after mortgage payment of $350 per unit, your yearly income would be $25,500 estimated. You would also be building equity by the appreciation of seven versus one property. 

Non-conforming 10% Down Investor Loans: The typical “Conforming Fannie Mae Loan” requires a 20% down payment. 10% down loans are not a standard Fannie Mae product. The advantage of 10% loans is they can double the number of properties purchased by comparison. You should be aware that mortgage insurance will be normally involved. Some non-conforming loans do not have mortgage insurance but may have a higher interest rate. To compare, have your mortgage banker do a truth in lending estimate to compare yields to see which one is best. Non-conforming loans are usually subject to a 1% origination fee. 

Originator -- in a Securitization transaction, the entity that created the assets that are part of the finance deal.  Typically a mortgage broker or a company looking to restructure its debt

Prepayment - Repaying a loan's principal balance before maturity date.  Some securitized loans either do not allow prepayment, or have prepayment penalties.  From the portfolio's standpoint, prepayment is a risk that will decrease the value of the portfolio.    

Portfolio Lenders -- Financial institutions that hold loans within their investment portfolio rather than selling to the secondary mortgage market.  

Return on Investment: Like Cap Rate, this is an essential calculation because it brings in multiple variables like holding time, appreciation, closing cost, expenses, property management, vacancy rates, and tax and expenses on point of sale. There are computer programs that I can use to show you what an estimated annualized after tax return will be. It is important to use conservative figures when evaluating this. Appreciation, vacancy rates, and expenses can change over the course of say ten years of holding the property. In conjunction with other evaluations it can give you valuable insight to the quality of the investment. However, for the bottom line depend more on positive cash flow that in appreciation. Appreciation is the icing on the cake. 

Reverse Mortgages – designed for homeowners age 62 and above, a reverse mortgage allows you to receive cash advances from the equity in your home without the need for repayment as long as you and/or any co-owner live in the home. The lender must be repaid when you sell the home, leave the home permanently, or die. 

Servicer, Primary -- With Mortgage Backed Securities and other Securitization transactions, the Primary Servicer maintains direct contact with the borrower, typically the loan originator or Mortgage Banker who sourced the loan.  

Servicer, Master -- With Mortgage Backed Securities and other Securitization transactions, the Master Servicer services (collects loan payments) the loan until maturity and is responsible for ongoing interaction with the borrower.

Servicer, Special -- When a securitized loan goes into default or is assumed, the Special Servicer takes over servicing the loan.

Supplemental Financing -- Both Freddie Mae and Fannie Mac allow the re-sizing of a loan if the collateral's property value appreciates by a preset amount.  

Tranche -- with Mortgage Backed Securities, tranche refers to one of several related securitized bonds offered as part of the same portfolio of mortgages.  The trust owning the mortgages divides these mortgages into a series of "tranches" or "classes" that are of varying risk of default, terms, yield, and payment priority.  Bonds are then issued backed by the mortgages assigned to the tranches and are rated by independent bond rating agencies; the trust will have various bonds rated from investment grade to an unrated class. The Security's indenture (the security's governing legal document) often describes the payment of the tranches in a section called the waterfall because it describes the moneys flow to the various classes of bond holders.  

1031 Tax Deferred Exchange: The government does allow you to sell a property, reinvest your money in like kind rental property, and defer any capital gains and recapture taxes. It is important that you know the rules, so please read the article more fully describing the tool.  

Retirement Accounts: Roth Individual Retirement Account (IRA) – with a Roth IRA, distributions may be taken at any time, tax-free and without penalty. 401(k)/403(b) Plan – if you participate in an employer-sponsored deferred compensation retirement savings plan, you may make withdrawals after age 59 ˝ without penalty; such withdrawals are taxed as ordinary income.  Self Directed Retirement Accounts may be used as a vehicle to own real estate. 

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