Glossary of Terms

The Patch of Land Index.

Term Library

Accredited Investor

An investor with a certain level of income or net worth who is thus able to participate in a private placement of securities (such as membership interests in a limited liability company) without being counted toward the maximum number of investors that are otherwise permitted in an offering exempted under Regulation D of the Securities Act of 1933. Such an investor does not need to meet the "sophistication and experience" requirements that are applicable to other investors, and if the securities in an offering are sold only to accredited investors, then there are no special information requirements.

The most common accreditation criteria for an individual includes (roughly):

  • » an individual with income exceeding $200,000 in each of the two most recent years (or joint income with his/her spouse exceeding $300,000 in each of those years) and a reasonable expectation of reaching the same income level in the current year; OR
  • » an individual with a net worth (or joint net worth with his/her spouse) exceeding $1 million, excluding the person's primary residence.

For additional information on who qualifies as an accredited investor, including how an LLC, Corporation, or Trust can qualify as “accredited investors,” see here and here

Alternative Finance

Alternative financing refers to a particular type of financial service, namely sub-prime lending (that is lending to people with relatively poor credit) by non-bank financial institutions. Alternative financing allows smaller businesses and people with low credit to finance projects as traditional banks will most likely not approve their loans. Peer to peer lending is a form of alternative financing.

Alternative Investments

An investment that is not one of the three traditional asset types (stocks, bonds and cash). Alternative investments include hedge funds, managed futures, real estate, commodities and derivatives contracts. Alternative investments are favored mainly because their returns have a low correlation with those of standard asset classes. Because of this, many large institutional funds such as pensions and private endowments have begun to allocate a small portion (typically less than 10%) of their portfolios to alternative investments such as hedge funds. While the small investor may be shut out of some alternative investment opportunities, real estate and commodities such as precious metals are widely available

Amortization

The gradual paying off of a debt by periodic installments.  Example: a $100,000 loan is arranged at an 8% interest rate.  The borrower pays $10,000 in the first year.  Of that payment, $8,000 is for the interest owed, and the remaining $2,000 serves to amortize the loan balance.  After that payment, the loan balance will have been amortized to $98,000.

Anchor Tenants

Usually the first, and the leading, tenant in a shopping center whose prestige and name recognition attracts other tenants and, it is hoped, shoppers. Anchor tenant generally pays rent rate lower than that paid by ancillary tenants.

Appraisal

An estimate of value, generally made by a professional appraiser (certified to meet certain education, experience, and knowledge requirements) who uses a systematic approach or process (including the analysis of market data) in order to reach a conclusion.  An appraisal of a property might be made not only to determine a reasonable offering price in a sale, but also to determine an appropriate loan size of a loan, to allocate a purchase price between land and building (improvements), to determine an appropriate amount of hazard insurance, or for estate tax purposes at the owner's death.

3 major types of appraisals:

Sales Comparison Approach: Sales comparison approach compares compares a subject property's characteristics with those of comparable properties which have recently sold in similar transactions. PoL uses this.

Cost Approach: In cost approach pricing, the market price for the property is equivalent to the cost of land plus cost of construction, less depreciation. It is often most accurate for market value when the property is new.

Income Approach: The income approach is computed by taking the net operating income of the rent collected and dividing it by the capitalization rate (the investor's rate of return). It is most typically used for income producing properties

Related Article: Appraisal vs. Home Market Evaluation

ARV (After Repair Value)

After Repair Value (ARV) is the projected value of a property after repairs have been made to it, based on comparable properties in the area.

ARV% = (Price+Repair Cost)/After Repair Value

Related Article: LTV vs. ARV

Average Daily Rate

Average Daily Rate represents the average rental income per paid occupied room within a given time period, usually the average realized room rental per day. ADR along with the property's occupancy are the foundations for the property's financial performance.

Bonds

A bond is a debt investment in which an investor loans money to an entity (typically corporate or governmental) which borrows the funds for a defined period of time at a variable or fixed interest rate. Bonds are used by companies, municipalities, states and sovereign governments to raise money and finance a variety of projects and activities. Owners of bonds are debtholders, or creditors, of the issuer.

Source: Investopedia

Related Article: 6 Alternatives to Investing in the Stock Market

Bridge Loan

A short-term loan that is used until a person or company secures permanent financing or removes an existing obligation. This type of financing allows the user to meet current obligations by providing immediate cash flow. The loans are short-term (up to one year) with relatively high interest rates and are backed by some form of collateral such as real estate or inventory. For example, let's say that a company is doing a round of equity financing that is expecting to close in six months. A bridge loan could be used to secure working capital until the round of funding goes through. In the case of an individual, bridge loans are common in the real estate market. As there can often be a time lag between the sale of one property and the purchase of another, a bridge loan allows a homeowner more flexibility.

Capitalization Rate (Also known as Cap Rate)

Capitalization rate, also known as cap rate, helps in evaluating a real estate investment and is rate of return on a real estate investment property based on the expected income that the property will generate. This rate can be used to estimate the investor's potential return on investment.

Formula:
Capitalization Rate = Yearly Income/Total Value

Certificate of Deposit (CD)

A savings certificate entitling the bearer to receive interest. A CD bears a maturity date, a specified fixed interest rate and can be issued in any denomination. CDs are generally issued by commercial banks and are insured by the FDIC. The term of a CD generally ranges from one month to five years.

A certificate of deposit is a promissory note issued by a bank. It is a time deposit that restricts holders from withdrawing funds on demand. Although it is still possible to withdraw the money, this action will often incur a penalty.

For example, let's say that you purchase a $10,000 CD with an interest rate of 5% compounded annually and a term of one year. At year's end, the CD will have grown to $10,500 ($10,000 * 1.05).

CDs of less than $100,000 are called "small CDs"; CDs for more than $100,000 are called "large CDs" or "jumbo CDs". Almost all large CDs, as well as some small CDs, are negotiable.

Source: Investopedia

Related Article: 6 Alternatives to Investing in the Stock Market

Crowdlending

In brief, Crowdlending is when individuals lend you money.This is important because oftentimes banks don't want to lend money to entrepreneurs and small business owners.Crowdlending eliminates the banks as an intermediary and allows individuals to lend money to other individuals. Another name for Crowdlending is "peer to peer" lending.

Day-Count Convention (30/360)

Day-count convention determines how interest accrues over time for a variety of investments including: bonds, notes, loans, mortgages, medium-term notes, swaps, and forward rate agreements (FRAs). This system is important in calculating accrued interest and present value. There are several different types of day-count convention methods. For example, a 30/360 day-count convention assumes there are 30 days in a month and 360 days in a year. 

Related Article: Understanding the 'Day-Count Convention' of Calculating Interest (30/360)

 

Debt Service

Debt service is the amount you pay on a loan in principal and interest over a period of time (Usually calculated for a year).

Debt Service Coverage Ratio (DSCR)

Debt service coverage ratio is the amount of cash flow available to meet annual interest and principal payments on debt, including sinking fund payments. This ratio is typically used by a lender when determining income property loans. This ratio should ideally be over 1. That would mean the property is generating enough income to pay its debt obligations.

General calculation:
DSCR = Net Operating Income / Total Debt Service


Click here for a more detailed video

Deed of Trust

A legal instrument used in many states in lieu of a mortgage, where legal title to a property is vested in one or more trustees to secure the repayment of a loan.

A deed of trust involves three parties: a lender, a borrower, and a trustee. The lender gives the borrower money. In exchange, the borrower gives the lender one or more promissory notes. As security for the promissory notes, the borrower transfers a real property interest to a third-party trustee. Should the borrower default on the terms of her loan, the trustee may take full control of the property to correct the borrower's default.

Default

Failure to fulfill an obligation or promise, or to perform specific acts.

Related Article: Default Scenarios

Distributions

Distributions of income and capital gains that mutual funds make to their investors periodically during a calendar year.

Example: Mutual funds pay out interest and dividend income received from their portfolio holdings as dividends (income distribution) to fund shareholders. In addition, capital gains from the portfolio's trading activities are generally paid out (capital gains distribution) at the end of the year.

Due Dilligence

Reasonable effort to obtain accurate and complete information in advance of a major decision; in real estate, this usually refers to the inquiries made in advance of a purchase or investment in a property.  Due diligence considers the physical, financial, legal, and social characteristics of a property and its expected investment performance.  The underwriting of a loan or investment is a form of due diligence, in the sense that constitutes a relatively detailed it risk assessment of that loan or investment. (i.e. Local market conditions and competition, environmental hazards)

Related Article: Debt Crowdfunding Due Diligence, Due Diligence and Underwriting Process

Escrow

A financial instrument held by a third party on behalf of the other two parties in a transaction. The funds are held by the escrow service until it receives the appropriate written or oral instructions or until obligations have been fulfilled. Securities, funds and other assets can be held in escrow.

First Lien

A lien (often a deed of trust or a mortgage) that has priority over all other liens.  In cases of foreclosure, the first mortgage will be satisfied before other mortgages.

Related Article: Default Scenarios

Fix & Flip

A type of business / investment strategy involving the purchase of properties requiring some immediate repairs to attempt to make a profit by selling the house quickly at a higher price.

Related Article: Fix & Flip Tips, Fix & Flip Real Estate Investing, Best Flippin Series Ever

Foreclosure

A situation in which a homeowner is unable to make full principal and interest payments on his/her mortgage, which allows the lender to seize the property, evict the homeowner and sell the home, as stipulated in the mortgage contract.

Related Article: Zombies Attack Real Estate

High-Density Population Area

Population density is the number of people per unit of area, usually quoted per square mile (or Kilometer). A high-density population area would typically be a major metropolitan city, or county.

Illiquid Asset

An asset that is not readily convertible to cash.  Real estate is generally considered an illiquid asset because it may take an extended period of time to accomplish a sale, depending on market circumstances.

Individual Retirement Account (IRA)

An investing tool used by individuals to earn and earmark funds for retirement savings. There are several types of IRAs including Traditional IRAs and Roth IRAs.

Traditional and Roth IRAs are established by individual taxpayers, who are allowed to contribute 100% of compensation (self-employment income for sole proprietors and partners) up to a set maximum dollar amount. Contributions to the Traditional IRA may be tax deductible depending on the taxpayer's income, tax filing status and coverage by an employer-sponsored retirement plan. Roth IRA contributions are not tax-deductible.

Source: Investopedia

Related Article: 6 Alternatives to Investing in the Stock Market

Interest

The charge for the privilege of borrowing money, typically expressed as an annual percentage rate.

Lien

A charge against property making it security for the payment of a debt, judgment, mortgage or taxes; it is a type of encumbrance.

Example:  David wants to buy a home, but needs a loan to complete the purchase.  David offers a lender a mortgage, which would create a lien on the property as security (collateral) for the payment of the debt.

LLC (Limited Liability Company)

A legal organizational form offering limited liability protection for the owners and which may be treated as a partnership for federal income tax purposes.  An LLC is often used as a way to own real estate because it provides many of the legal advantages of a corporation along with the tax advantages of a partnership.

LTC (Loan to Cost Ratio)

A ratio used in commercial real estate construction to compare the amount of the loan used to finance a project to the cost to build the project. If the project cost $1 million to complete and the borrower was asking for $800,000, the loan-to-cost (LTC) ratio would be 80%. The costs included in the $1 million cost figure would be land, construction materials, construction labor, professional fees, permits and so on.

LTV (Loan to Value Ratio)

The amount borrowed compared to the cost or value of the property purchased.  Lenders often require that a loan-to-value ratio not exceed a specified amount, unless a borrower also purchases mortgage insurance.

Example:  Susan borrows $75,000 of the total $100,000 purchase price of her home.  The loan-to-value ratio is 75%.

Related Article: LTV vs. ARV

Maturity

Example: A mortgage loan may have a maturity of 30 years.  Periodic payments are established so that the loan principal will amortize by the maturity date.

Mortgage

A debt instrument, secured by the collateral of specified real estate property, that the borrower is obliged to pay back with a predetermined set of payments. Mortgages are used by individuals and businesses to make large real estate purchases without paying the entire value of the purchase up front.

Example:  Tom wants to buy a home, but needs a loan to complete the purchase.  As collateral, Tom offers a mortgage on the property to a lender; if Tom later defaults on the loan, the lender has a lien on the property from the mortgage, and can take possession of the property.

Net Operating Income (NOI)

Net operating income (NOI) is a calculation used to analyze real estate investments that generate income. Net operating income equals all revenue from the property minus operating expenses.

A property might generate revenue from a number of sources (rents, parking fees, and other services such as vending and laundry machines). Operating expenses are those required to run and maintain the building and its grounds (insurance, property management fees, utilities, property taxes, repairs and janitorial fees).

NOI is a before-tax figure that also excludes principal and interest payments on loans, capital expenditures, depreciation and amortization.

Occupancy Rate

Occupancy rate is the number of units in a building that are rented compared to the total number of units in the building.

Example:
An apartment building has 25 units, 15 of which have been rented out. Therefore, the building would have a 60% occupancy rate.

Passive Income Investing

An investment strategy involving limited ongoing buying and selling actions. Passive investors will purchase investments with the intention of long-term appreciation and limited maintenance. Unlike active investors, passive investors buy a security and typically don't actively attempt to profit from short-term price fluctuations. Passive investors instead rely on their belief that in the long term the investment will be profitable. Real estate is a common form of passive investing.

Peer to Peer Lending

A method of debt financing that enables individuals to borrow and lend money - without the use of an official financial institution as an intermediary. The advantage to the lenders is that the loans generate income in the form of interest, which can often exceed the amount interest that can be earned by traditional means (such as from saving accounts and CDs). Plus P2P loans give borrowers access to financing that they may not have otherwise gotten approval for by standard financial intermediaries. The method is not without its disadvantages as the lender has very little assurance that the borrower, who traditional financial intermediaries may have rejected due to a high likelihood of defaults, will repay their loan. Furthermore, depending on the lending system employed, in order to compensate lenders for the risk that they are taking, the amount of interest charged for peer to peer loans may be higher than traditional prime loans.

Peer to Peer Loans

A loan given to an unrelated individual without going through a traditional financial intermediary such as a bank or other traditional financial institution.

Personal Guarantee

Agreement that make one liable for one's own or a third party'sdebts or obligations. A personal guarantee signifies that the lender (obligee) can lay claim to the guarantor'sassets in case of the borrower (obligor) default. A personal guarantee allows a business owner to borrow by putting his or her personal finances on the line (the individual's credit score and assets are at risk). A regulation made by the Securities and Exchange Commission, under the Securities Act of 1933, that sets forth conditions to be satisfied in order to qualify for a private offering exemption from registration.

Related Article: Default Scenarios

Portfolio

A group of investment assets.

Example: Dan's real estate portfolio consisted of equity shares of three retail shopping centers, two multi-family buildings, and one self-storage facility, and also included shares of loans on a hotel and two single-family residences.

Prefunding (or Prefunded Loans)

Once Patch of Land decides to host a project on its platform then they will prefund the loan for the Borrower. In turn, the Borrower will receive the funding they need up front to secure the investment property, close, and begin working on the first phase of construction right away. This may sound like standard practice, however, most crowdfunding platforms will only host a project for investors to participate in, and will not move forward with the project until it’s been fully funded by the crowd.


The key benefit of prefunding for real estate developers is the ability for them to receive a large sum of capital and move fast before their window of opportunity closes. Prefunding also has additional benefits for investors since those who have invested in any of our investment properties will begin earning interest as soon as their funds clear escrow. Ultimately, Patch of Land prefunds loans because we respect the principle of time equals money.

The Benefits of Real Estate Prefunding

Preliminary Title Report

A report issued by a title company before a transaction, stating a willingness to insure title upon closing.

Example: The buyer's attorney arranged for a preliminary title report when the property was put under contract, to discover whether there were any legal or title impediments to be cleared before closing.

Principal

The amount of money raised by a mortgage or other loan that still remains after some of that amount may have been amortized by earlier payments.  Principal can be contrasted to the interest paid on the loan.

Example:  Harry arranged a amortizing loan of $100,000 principal amount at a 6% interest rate.   The first monthly payment is $1,200 and includes $500 interest and $700 of principal amortization; following the payment, the principal balance be $99,300.

Rent Rolls

A register of rents including the names of tenants and the amount of rent they pay. This typically involves an official written record of names or events or transactions.

Reg D (Regulation D)

A regulation made by the Securities and Exchange Commission, under the Securities Act of 1933, that sets forth conditions to be satisfied in order to qualify for a private offering exemption from registration.

Example: Syndicator Nancy wants to sell membership interests in a limited liability company (LLC) that will own a portion of an office building.  She uses Rule 506 of Regulation D to sell such interests only to accredited investors, to avoid the need of registering a public offering, thereby saving money and several months of delay.

Related Article: Rule 506c Filings, Reg D Explained in a Video

REIT (Real Estate Investment Trust)

A Real Estate Investment Trust, or REIT, is a real estate mutual fund, allowed by income tax laws to avoid the corporate income tax if it limits its investments to real estate or mortgages and meets certain other requirements such as annually distributing 90% or more of its income to shareholders.  Some of these restrictions can limit the maneuverability of REITs, which also tend to focus only on "core" properties with limited capital appreciation potential.

REIT Investing

When you buy a share of a REIT, you are essentially buying a physical asset with a long expected life span and potential for income through rent and property appreciation. This contrasts with common stocks where investors are buying the right to participate in the profitability of the company through ownership. When purchasing a REIT, one is not only taking a real stake in the ownership of property via increases and decreases in value, but one is also participating in the income generated by the property. This creates a bit of a safety net for investors, as they will always have rights to the property underlying the trust while enjoying the benefits of their income.

REIT Investments

Individuals can invest in REITs either by purchasing their shares directly on an open exchange or by investing in a mutual fund that specializes in public real estate. An additional benefit to investing in REITs is the fact that many are accompanied by dividend reinvestment plans (DRIPs). Among other things, REITs invest in shopping malls, office buildings, apartments, warehouses and hotels. Some REITs will invest specifically in one area of real estate - shopping malls, for example - or in one specific region, state or country. Investing in REITs is a liquid, dividend-paying means of participating in the real estate market.

Rehab Project

The process of restoring and improving a property to a satisfactory condition through repair and renovation. Rehabs bring a property back to a preferable manner of living which makes contemporary use possible while still preserving significant character-defining features. This also includes adaptive use.


Fix and Flip Real Estate Investing
Buy and Hold Real Estate Investing

Risk

Uncertainty or variability; the possibility that returns from an investment will be less than forecast, or that invested principal might be lost.  Diversification of investments provides some protection against risk.

Example:  Types of risk in real estate include (1) business risk, involving the project type, its management, and its market area, and how each of these factors might affect rents, vacancies and operating expenses; (2) financial risk, meaning both the uncertainty of the equity return when debt financing is used and the variability of interest rates that might affect a property's debt service or its ultimate sale price; (3) inflation and other universal "systemic" risks like war or significant political changes,  (4) liquidity risk, meaning whether (and when) the investment can be "cashed out," and (5) variance or sensitivity risk, referring to the degree of variability of any of the foregoing risks.

Risk vs. Return

A financial concept that attempts to compare the potential fluctuations of an investment with the projected return associated with it.  Increased risks require that an investor demand increased returns in compensation; people don’t normally accept the same rate of return on a very risky investment that they can already get on a low-risk investment.

Example: An expected return of two (2) percentage points above the rates paid by U.S. Treasury bonds may be considered sufficient reward for investing in mortgage securities if the historical default rate of such securities has been at 1%.

Example:  An expected return of ten (10) percentage points above the U.S. Treasury rates may be needed to invest in unsecured credit card debt, if the historical default rate on such debt has been at 5%.

SEC Syndication

The Commission is adopting amendments to the rule under the Investment Company Act of 1940 that permits a registered investment company ("fund") that has certain affiliations with an underwriting participant to purchase securities during an offering. The amendments expand the exemption provided by the rule to permit a fund to purchase U.S. government securities in a syndicated offering. These amendments are intended to respond to recent changes in the method of offering certain U.S. government securities.


The JOBS Act Explained in a Video

Self-Directed IRA (SDIRA)

An investing tool used by individuals to earn and earmark funds for retirement savings. There are several types of IRAs including Traditional IRAs and Roth IRAs.

Some investment types, such as life insurance, are still not permitted in an IRA. In addition, investments cannot be employed for personal use or gain. For example, an investor cannot hold real estate that is personally used in a self-directed IRA. It is the responsibility of the investor to comply with all IRS regulations.

Source: Investopedia

Related Article: 6 Alternatives to Investing in the Stock Market

Title

Evidence that the owner of real property is in lawful possession thereof; it is evidence of ownership.  Usually a property owner transfers his title by means of a legal document called a “deed,” which must be in writing and meet other local requirements.  A deed should convey good and marketable title; “good” means that the title is valid, and “marketable” means that it is reasonably free from doubt or litigation, so that it can be readily sold.  

Example: Title to land does not mean merely that a person has the right of possession, because one may have the right of possession but not have title.  Title is evidence of true ownership of the land, with all the rights that signifies.

Example: Karen sold land to Susan.  Title to the property was transferred at closing by the deed that Susan received.

Title Insurance

An insurance policy that assures good title is transferred in the course of a sales or financing transaction.  This insurance covers the legal fees and expenses that may be necessary if a claim is made against one's ownership of the property.  Different title policies offer different extents of coverage; for example, one can purchase "standard" coverage or "extended" coverage.

There are two common types of policies: a lender's policy that protects a lender (or the "mortgagee") on the property, and a buyer's policy that protects the buyer (or the "mortgagor").

Transparency

In finance, a manner of doing business such that activities are fully disclosed and reported to investors.  Such policies make it possible for potential investors to adequately estimate the risk, and to forecast the income, from investing.

Related Article: Transparency through Patch of Land's Platform

Value-Add

Value-add generally refers to a property that is currently in less than stellar condition and in need of improvements that are of somewhat higher risk, such as performing more-than-usual renovations like upgrading exteriors and interiors and curing deferred maintenance.  The value-add categorization implies higher risk than the category of core plus, but less than opportunistic.

Yield

Another term for the internal rate of return (IRR), a measure of an investment's return rate that takes account of the time value of money.