Capital Expenses or Cap Ex

Improvements (as opposed to repairs) to a fixed asset that will increase the value or useful life of that asset. A capital expenditure is typically amortized or depreciated over the useful life of the asset, as opposed to a repair, which is expensed in the year incurred.

Capitalization Rate or Cap Rate

Unlevered initial return from the acquisition of a real estate asset calculated by dividing net operating income (NOI) by the property sales price. For example, a property’s capitalization rate (cap rate) is 10 percent if it is purchased for $10 million and produces $1 million in NOI during a year. The cap rate is typically calculated using the NOI generated in the first year of ownership so investors can normalize and compare potential returns among competing investment properties. The Stabilized Cap Rate which is the ratio between the net operating income produced by a property upon achieving target occupancy and its purchase value.

Debt Coverage Ratio

The debt coverage ratio is the ratio of the net operating income to the mortgage payment. If net operating income is projected to change over time, the investor typically reports the first year’s net operating income.

DCR = Net Operating Income / Total Debt Service

Debt Service

The cash that is required to cover the repayment of interest and principal on a debt placed on the asset for a particular period.

Cash on Cash Return

CoC is used to measure the ratio between an asset’s annual cash flow in relation to the amount of capital invested. Like NOI CoC is also typically calculated before tax.

Cash on Cash Return = Annual Pre-Tax Cash Flow / Total Cash Invested

Net Operating Income (NOI)

The income generated after deducting operating expenses but before deducting taxes and financing expenses.

NOI = (Rental Income + Other Income – Vacancy and Credit Losses) – Operating Expenses

NOI does not include loan payments, depreciation, amortization, or capital expenditures, and is always calculated before tax.

Net Cash Flow

Net cash flow is the annual income produced by an investment property after deducting allowances for debt service, capital expenditures, and other non-operating expenses from net operating income.

Net Cash Flow = NOI – (Debt Service + Capital Expenses + Other Non-Operating Expenses)

Loan to Value Ratio (LTV)

The ratio between a mortgage loan and the value of the property pledged as security, usually expressed as a percentage.

Loan to Value Ratio = Mortgage Amount / Appraised Asset Value

1031 Exchange or Like-kind Exchange

U.S. Internal Revenue Code Section 1031 permits the deferral of capital gains taxes on the sale of property held for investment or productive use in a trade or a business. With a 1031 exchange, property owners can sell their real estate and then reinvest the proceeds in ownership of a like-kind property or several like-kind properties, thus deferring the capital gains taxes. The like-kind exchange under Section 1031 is tax-deferred, not tax-free. When the replacement property is ultimately sold (not as part of another exchange), the original deferred gain, plus any additional gain realized since the purchase of the replacement property, is subject to tax.

Value Add Investment

An investment in a real estate asset with existing cash flow (and value) that can be increased by raising occupancy, rents or both. Owners typically carry out one or more of the following to add value to a building: improve or replace building systems, provide new finishes, introduce new amenities, improve access or circulation to the building, add square footage, etc.