In part 1, we introduced important terms in the commercial real estate industry with our LoanBoss dictionary (a part of our training program for new hires). In part 2, we're introducing a few more words — and very important metrics — for you to get acquainted with. From A to Z (minus a few letters), here are a few important words to know in the commercial real estate industry.
Arm’s length transaction: Business deal in which buyers and sellers act independently without one party influencing the other.
Assumption: Provision in a mortgage contract that allows the seller of an entity to pass responsibility for the existing mortgage to the buyer. Someone taking over a loan for the current Borrower - “assuming” the obligations of the loan.
Bad Boy Carve-out (exceptions): Used in non-recourse/limited recourse loans. Provides for personal liability against the borrower and principles of the borrower upon the occurrence of certain enumerated bad acts committed by the borrower or its principals.
Cap (Capitalization) Rate: Indicates the ROR that is expected to be generated on a property.
- Calculated by dividing NOI by Current Market Value.
- Percentage is an estimation for an investor’s potential return on an investment property.
- Assesses investment property for profitability and return potential.
Conversion Option: The ability for a loan to convert to a different type of rate throughout the term of the loan based on certain conditions. For example, if the Lender gives the Borrower the option to convert to a fixed rate, from a floating rate, based on different requirements.
Cost of Funds: Another term for the interest rate (how much it will cost borrower to borrow $).
DSCR: Debt Service Coverage Ratio
- Illustrates how easily borrower can cover payments.
- Measure of Cash Flow to pay current debt obligations.
- NOI/Debt Service (P&I payments).
- Higher = better (means higher cashflow).
- Return the lender makes from property after foreclosure.
- Related to risk
- Lower DY indicated higher leverage and therefore higher risk
- Higher DY indicates lower leverage and lower risk
Impositions: Usually referring to Tax and Insurance Reserves.
LIBOR: London Interbank Offer Rate
- Interest rate used in lending between banks on the London Interbank market and also used as a reference for setting the interest rate on other loans
- Most common index for floating rate deals
- Federal reserve determines floating rates (meets every 6 weeks)
- Fixed rates are determined by market
- Provides a lender the legal right to seize and sell the collateral property or asset of a borrower who fails to meet the obligations of a loan.
LTV: Loan to Value
- Number lenders use to determine how much risk they’re taking on with a secured loan
- Lower = better
- Ratio of Loan Amount/Property Value
Margin: Rate added to index to determine floating interest rate.
Max Cap Strike: Rate on a Cap confirmation.
Non-Recourse: Type of loan secured by collateral, which is usually property. If the borrower defaults, the issuer can seize the collateral but cannot seek out the borrower for any further compensation, even if the collateral does not cover the full value of the default amount.
Notional: (Notional principal amount or notional value) is the nominal or face amount that is used to calculate payments made on that instrument.
Open Period: Amount of time, measured in months, between a defined date (including Maturity) and when Present Value or Reinvestment Yields are determined. Look for this language in Make Whole and Yield Maintenance prepay sections.
Recourse: About of liability a Guarantor(s) is responsible for if the Borrower defaults on a loan.
Revolving Loan: Like a line of credit. Borrowers are able to borrow, repay and re-borrow money. Loan amount behaves like a credit limit.
SOFR: Secured Overnight Financing Rate
- Benchmark interest rate for dollar-denominated derivatives and loans that is expected to replace LIBOR
- Is based on transactions in the Treasury repurchase market and is seen as preferable to LIBOR since it is based on data from observable transactions rather than on estimated borrowing rates, as is sometimes the case with LIBOR
Strike: Maximum rate an interest rate can go before Lender will make payments to a Borrower (found on Cap Agreements).
Subrogation: The substitution of one person or group by another in respect of a debt or insurance claim, accompanied by the transfer of any associated rights and duties.
Usury: Illegal action or practice of lending money at unreasonably high interest rates.
Have any others you think we should add to our dictionary? Email us at firstname.lastname@example.org.
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Don't forget to read CRE Terms To Know Part 1 for more words you need to know.