Real Estate Financing Terms
Acquisition and Development Loan (A&D Loan): This loan provides for the purchase and the preparation of raw land for subdivision use. It usually includes the streets and all of the utilities. The source of repayment is a construction loan or sale.Adjustable Rate Mortgage (ARM): A mortgage which permits the lender to adjust the rate of interest upwards or downwards in accordance with a specified index.Amortization: The retirement of the principal of a loan over a specified time at a specified rate of interest.
Appreciation: An increase in the value of an asset.
ARM: Adjustable Rate Mortgage (see above).
B: Billion, referring to dollars. For example: $1B is read “one billion dollars.”
Bond: An interest-bearing certificate issued by a government agency or business promising to pay the holder a specified sum on a specified date.
Bridge Loan: A loan that spans a gap between two other loans. This loan can arise if a builder wishes to pay off a higher interest construction loan but not sell the project for few years, when he believes the interest rates will improve. A bridge loan is usually outstanding for two to five years and can be prepaid with little or no penalty.
Broker: An intermediary between two or more persons engaged in a business transaction. Real estate brokers arrange sales between buyers and sellers. Mortgage brokers arrange loans between lenders and borrowers.
Buydown: A purchased reduction in interest rates and payments. For example, a developer may pay a lender to bring the interest rates on a home mortgage down three or four points for a period of three years. This allows the buyer to qualify at his income level, although the rate will climb to market level for him in the fourth year. There are other buydowns as well.
Cap Rate: An investor’s net yield used to determine the value of an income producing property.
Certificate of Deposit: A bank or S&L instrument representing the investment of funds for a guaranteed return.
Commercial Mortgage Backed Securities (CMBS): Securities sold to investors which are collateralized by commercial mortgages. Mortgages are pooled, securitized and sold to investors.
Commingled Funds: Accounts set up by lenders to attract pension fund dollars into real estate. These funds are either open-ended (investors can withdraw funds at any time) or closed-end (investors are committed once they invest). Commingled funds are also used to attract foundation and endowment money.
Construction Loan: Provides for the construction of a building or buildings. The lender usually makes portions of the funds available as construction progresses.
Contract of Sale (also Agreement for/of Sale): A contract in which the buyer agrees to purchase property from the seller and the seller relinquishes possession of the property but retains title until the loan has been paid.
Convertible Mortgage: A mortgage (usually 10 years) where the lender also retains the option to call the loan or assume a percentage of the equity in the property (in some cases it may be 100 percent) at some specified point during the term of the loan. Convertible mortgages are usually used only for commercial properties. The lender is usually a pension fund or other tax exempt entity. The loan usually covers all costs and sometimes includes a cash bonus for the developer.
Conveyance: The transfer of ownership of real property from one person to another or the document by which the transfer is effected.
Co-op: Where an association (corporation) owns a housing unit and members rent from the association. Members have the right to rent by virtue of the membership in the association. When members leave the unit, they can sell their membership to outsiders, but the outsider usually must be approved by the association.
Coupon Rate: The interest rate or rate of return printed on the face of the loan. This is not the true rate. Loan fees or points must be included to arrive at the true interest rate.
Credit Company: A lending organization whose source of funds is the stock market, the commercial paper market, commercial banks and the bond market.
Debt Service: The principal and interest required annually, quarterly or monthly by the note.
Debt Service Coverage (DSC) Ratio: Mathematical equation used by lenders to determine the amount of mortgage payments a building’s cash flow can support.
Debt/Equity Combination Mortgages: Where the lender requires a share of the equity in a project as well as interest and repayment of principal.
Deed of Reconveyance: After a loan has been retired the trustee (the holder of a trust deed) prepares a deed of reconveyance and records it. This action clears a trust deed and the trustee no longer claims title to the unleveraged property. (also see Trust Deed)
Discounted Income: This is a process by which lenders discount expected future income in order to express the future income dollars back to present value. The purpose is to find the value in today’s dollars of the inflated dollars to be received in the future.
Equity: 1) The degree of ownership an entity has in a property; 2) The value of a property beyond the amount owed on it in liens; 3) The amount of money raised by investors.
Eurodollars: Dollars located in banks outside U.S. borders. Interest rates for Eurodollar loans float, based upon supply and demand. Rates normally are very similar to U.S. CD rates. Terms are usually three years or less.
Fannie Mae: See Federal National Mortgage Association below.
Farmers Home Administration (FmHA): Makes direct loans for low and moderately priced housing in rural and small town areas.
FDIC: See Federal Deposit Insurance Corporation below.
Fed: The Federal Reserve System includes 12 regional reserve banks and a board of governors (The Fed) in Washington, D.C. The Fed supervises its member banks, issues regulations aimed at promoting sound banking practices, makes loans to banks in temporary need and controls the money supply. Reserve banks hold member banks’ reserves and issue new currency (Federal Reserve Bank notes).
Federal Deposit Insurance Corporation (FDIC): An agency of the federal government which insures accounts contained in member institutions and repays the depositors in the event that the bank or S&L should fail. In the event of a failure, the FDIC will total all of a person’s deposits in the institution, including savings accounts, checking accounts, CDs and other deposits and reimburse for loss up to a maximum of $100,000.
Federal Home Loan Mortgage Corporation (FHLMC, Freddie Mac): Freddie Mac buys conventional loans from S&Ls, banks and mortgage bankers. Most of the loans bought by Freddie Mac are packaged into pools and sold to investors as securities (called Participation Certificates or PCs). Freddie Mac also guarantees pools of mortgages held by local lenders (PC swaps). Local lenders can then sell the PCs as securities and not mortgages.
Federal Housing Administration (FHA): A government agency which insures mortgages.
Federal National Mortgage Association (Fannie Mae): Fannie Mae buys conventional loans from banks, S&Ls and mortgage bankers. It packages some of the loans as securities and then sells them to Wall Street investors.
FHA: See Federal Housing Administration above.
Fixed Rate Mortgage: A mortgage on which the rate of interest remains constant throughout the life of the loan.
Fixed Rate Mortgage With An Early Call: This is a traditional fixed rate mortgage, but the lender has the option to call the loan due and payable (usually in less than 10 years). LCs and some S&Ls offer this program.
Floating Rate Mortgages: Lenders offer these mortgages with 25 to 30 year amortizations. The rate moves with the float of the bank’s prime rate. This type is often issued to smaller projects requiring intensive management. Large projects require a very strong borrower and heavy cash.
FmHA: See Farmers Home Administration above.
Forward Commitment: A pledge from a lender to provide a loan at a future date. These commitments often are used as takeouts to secure construction loans.
Forward Equity Takeouts (also Forward Equity Commitments): Advance purchase commitments. LCs write forward commitments to purchase the project upon completion. Often a minimum leaseup is required. The commitment can be used to arrange the construction loan just like a forward mortgage commitment. These usually cover all of the developer’s costs plus a profit.
Freddie Mac: See Federal Home Loan Mortgage Corporation above.
General Accounts: The accounts into which insurance company cash flow goes. Pension fund cash invested in General Accounts earns the same rate that the life company earns (minus a management percentage for the LC).
GIC: See Guaranteed Investment Contract below.
Ginnie Mae: See Government National Mortgage Association below.
Government National Mortgage Association (GNMA, Ginnie Mae): A HUD agency. GNMA attracts capital into the mortgage market by guaranteeing pools of mortgages that have previously been guaranteed by FHA and VA with a U.S. Treasury guarantee. GNMA also buys below-market-rate mortgages which are federally subsidized or are part of a guaranteed housing program for low and middle income families. The agency sells these loans to FNMA or other investors at market rates, absorbing the difference as a housing subsidy.
Guaranteed Investment Contract: The money market instrument issued by life insurance companies to pension funds, guaranteeing a fixed rate of interest for a guaranteed time period.
Hedging: a complicated procedure which basically allows a borrower to pay what amounts to a fixed rate on a floating rate loan.
HR10: IRA-like legislation allowing the self-employed U.S. citizen to set aside a portion of his income annually for investment and savings for future retirement.
Hyperinflation: Inflation which has grown out of control.
Hypothecate: Pledging something (a pool of mortgages or a shopping center, for example) to secure a loan. Usually overcollateralization (where the value of the pledge far exceeds the value of the loan) is involved.
IMF: See International Monetary Fund below.
Indexing: Relating the rate of a loan to the numerical behavior of an index, for example, the 11th District Cost of Funds Index (COFI) or the Consumer Price Index (CPI).
Industrial Revenue Bond (IRB): A bond to be used for the construction or rehabilitation of public buildings and installations which is to be retired by the income from the building or installation. IRB income is exempt from federal taxation, some municipalities’ and states’ taxation, and some foreign countries’ taxation.
Interim Loan: A short term real estate loan of any type, payable in two years or less.
Intermediate Loan: A loan maturing between six and nine years of origination. Intermediate loans usually require amortization of the principal. The due date is usually shorter than the amortization term.
Internal Rate of Return (IRR, Discounted Cash Flow): A forecast designed to estimate the net rate of return over a period of future time by comparing the present value of future benefits to the present value of the investment outlay. The process requires estimates of future inflation and its effects upon income, expenses and future sale capitalization rates. The purpose of the IRR is to compare yields on investments which have different types of returns (bond interest versus real estate appreciation, for example).
International Monetary Fund (IMF): An association of governments to promote international cooperation, the expansion and growth of international trade, and exchange stability. The IMF permits members to adjust a poor balance of payments without resorting to destructive measures.
IRB: See Industrial Revenue Bond above.
Joint Venture (JV): A financial partner provides capital for a project and shares in the project’s profits. LCs and other institutional or private lenders may fund JVs in which all of the developer’s costs are covered. Usually the lender gets 50 percent of the ownership. The real negotiations relate to coverage of the developers’ fees and costs. JV lenders often require that their return be a preferred return.
Kicker: An additional return to a lender from a loan beyond the interest, the fee and the amortization of the principal. Example: the lender shares equity or income or both with the borrower after the project is completed. Kickers usually apply to permanent or term loans only.
Land Acquisition and Development Loan: See Acquisition and Development Loan above.
Land Loan: A loan in which the security is raw land.
Land Sale/Leaseback: A situation where an investor purchases land and then leases it back to the developer for a fixed rent and other considerations. The lender concurrently issues a mortgage on the leasehold at current market rates. This usually includes a kicker. This deal often provides more dollars than a mortgage.
LC: See Life Company below.
Leased Land Mortgage: A home mortgage where the lender retains title to the land while the borrower obtains title to the house. The borrower then pays land leasing fees to the lender. Sometimes there is a stipulation that the borrower be given the opportunity to purchase the land at some time during or after the term of the mortgage.
Letter of Credit: 1) A letter from a bank asking that the holder of the letter be allowed to withdraw specified sums of money from other banks or agencies, to be charged to the account of the writer of the letter; 2) An order in writing from a banker to his agent abroad authorizing payment of a sum of money to the person named in the letter; 3) An arrangement facilitating early payment for goods dispatched overseas.
Leverage: The amount of money owed through mortgages or liens on a piece of property.
Life Company (LC): A company which writes life insurance and annuities as its primary activity. Life companies also act as intermediaries for the investment of pension funds.
Limited Partnership: A syndication. The limited partners simply provide the money when called upon and have nothing to say about the overall operation of the income producing activities. Usually at some specified time, the assets of the partnership are liquidated and the partners share the profits.
Liquidation: 1) To settle the accounts of a bankrupt firm by apportioning assets and debts; 2) To convert holdings or assets into cash.
Liquidity: The ability to meet current financial liabilities with cash.
Lock-in: A loan provision providing that the loan cannot be paid off for a specified period of time.
M: Million, referring to dollars. For example: $1M would be read as “one million dollars.”
Matching Funds: A procedure used by lenders to make loans. They simply match a loan amount against an amount they have on deposit, often in CDs. They then add a spread to the interest rate to ensure that they get more money from the borrower than they have to pay the depositor. Usually used with short term loans.
Maturity: The time when a note or mortgage becomes due.
Mezzanine Loan (also see Second Mortgage): A loan that is subordinate to a first mortgage on a property. Typically used to maximize the leverage on a property and/or to meet a first mortgage lender’s qualification requirements.
Miniperm: A three to five year income property mortgage, usually made in conjunction with a construction loan.
Mortgage: Conveyance of property (as security for a loan) on condition that the conveyance becomes void on payment of performance, according to stipulated terms.
Mortgage Banker: A company that makes loans with its own funds and then sells the loans. The residential mortgage banker takes a risk of loss. The sale of a residential loan is usually made to a government agency such as Freddie Mac, Fannie Mae or Ginnie Mae. Mortgage bankers also sell to banks, life companies and S&Ls. Commercial mortgage bankers typically take no risk of loss, but do service the loans.
Mortgage Broker: A company which locates borrowers and lenders, and arranges loans between them. The mortgage broker takes no risk of loss and does not service the loans.
Negative Amortization: This occurs in a loan where the interest rate is higher than the payments actually paid and the excess interest accrues. This effectively increases the principal. The borrower owes more than his original balance.
Open End: 1) A construction loan without a takeout; 2) A commingled fund from which investors can, at least in theory, remove their funds at any time.
Over Prime (OP): Frequently, construction loans and other short term loans are negotiated at an interest rate which is a specified percentage over the prime rate. Example 2OP would read “two over prime,” meaning 2 percent over the bank prime.
Participating Mortgage: Many lenders offer this mortgage, which is similar to a traditional fixed rate mortgage, but which includes a kicker for the lender. The kicker is usually a percentage participation in the increases in gross income above the scheduled gross. Most of the borrower’s costs can be covered with these loans.
Par Value: The nominal, or face, value of stocks, bond securities, etc.
Pension Funds (PFs): 1) Accumulated capital, investments and other assets held by private corporations, unions, societies, public agencies, etc., for the present and future payment of retirement benefits to employees; 2) The organization within each company, union, society, public agency, etc., which is responsible for these monies, and for their collection, investment and disbursal.
Permanent: A permanent mortgage is a loan of 10 years or more. It is the same thing as a long term loan.
PF: See Pension Funds above.
Planned Unit Development (PUD): Planned development of a specified land area in such a way that the land is utilized for residential plus a common area for all of the homeowners. Non-residential projects can also be PUDs.
Points: This means percentage points. It usually refers to loan fees paid either by the buyer in a conventional loan or the seller in an FHA or VA loan. A point is nothing more than 1 percent of the loan amount.
Pools: Vehicles created by LCs, banks, syndicators and others to provide common receptacles of money from pension funds and other investors for the common purchase of real estate property or mortgages.
Portfolio: The collection of securities and other investments, including real estate, held by financial institutions.
Prepayment: Paying off a loan before it is actually due.
Prepayment Penalty: A monetary fine placed on a borrower who pays off a loan before it is due.
Present Value: Future currency income or value that would be required to produce today’s currency value. The future value if discounted to take into account expected inflation.
Prime Rate: The quoted rate on bank loans set by commercial banks and granted only to top borrowers. It is affected by overall business conditions, the availability of reserves, the general level of money rates, and may vary geographically. Most bank loans carry interest rates tied to a spread above or below the quoted prime rate.
PUD: See Planned Unit Development above.
Real Estate Investment Trust (REIT): The real estate equivalent of a mutual fund set up to attract individual and institutional dollars into real estate. The stock is called beneficial interests and is traded by stockbrokers.
Refinancing: Paying off an existing loan and writing a new loan to replace it.
Secondary Market: The market for the resale of mortgages. The market consists of Freddie Mac, Fannie Mae, private companies, the bond market and thousands of institutions. FHA, VA, GNMA and private mortgage insurance companies insure mortgages for the secondary market. The secondary market recycles money back to the primary lenders, who can then lend more money and create more mortgages for the secondary market to buy.
Second Mortgage: A loan collateralized by equity in a property with a first lien on it as well. Also known as a second trust deed in trust deed states.
Separate Accounts: Life companies (LCs) create separate accounts with specific objectives for investment capital from pension funds (PFs). Most LCs have a series of separate accounts such as stocks, bonds, mortgages, real estate ownership, etc. PF execs can choose how much to invest in each account and with which LC. This contrasts with general accounts where LCs reserve the right to choose the type of investment.
Servicing: The receipt of monthly payments from the borrowers, the keeping of records as to prepayment of principal, and the remittance of the appropriate principal and interest to the investor who owns the loan.
Short Term: A short term loan is any loan of five years or less. Most short term loans carry terms of one year or less.
Standby Commitment: The lender makes a commitment while not expecting to fund unless the project gets into trouble. The terms are usually rough. While no actual funding is usually involved, a developer can use a standby commitment to get a construction loan. Some lenders write standbys which are more affordable than others.
Standing Loan: Loans on improved property for a period not exceeding five years. Usually not amortized. “Standing” conveys the purpose of the loan. The object is to provide funds to pay off the construction lender or other first mortgage holder.
T: Thousand, referring to dollars. For example: $100T would be read “one hundred thousand dollars.”
Trust Deed (TD): Does not actually convey property but transfers an interest to the lender, not possession or use. A trust deed is used when a lender wants security on a loan. Title to the property in question is conveyed to a trustee, not to the lender. In the event of default, the trustee can sell the property to the highest bidder to satisfy the loan.
Underwriting: The process of determining whether a loan has proper collateral, guarantees and/or financial backing to be a proper investment.
Valuation: Process used by real estate specialists to fix the worth and true market value of properties; basically a judgement or appreciation of the worth of a property.
Warehousing: After the lender makes the loan, it temporarily holds the loan documents until the loan is sold. The funds to make the loan come from a commercial bank. These funds are called the warehouse line and the temporary holding period is called warehousing.
Wraparound: A mortgage in which the lender assumes the first mortgage. The debtor makes one mortgage payment to the wraparound lender who, in turn, sends the proper portion to the first mortgagee. The wrap lender usually receives a portion of his yield from the amortization of the first mortgage.
Yield: The ratio of cash received to cash invested, usually expressed as a percentage.