Investing in multifamily real estate is easier when you understand the practical terms you will encounter in your day-to-day operations. Some real estate terms may sound unfamiliar to new investors, while others may appear too similar and confusing to differentiate.
That said, let’s explore some of these must-know terms in detail to give you a better foundation in the commercial real estate industry.
Multifamily Real Estate Terms
1. Multi-Unit Property
A multi-unit property is a real estate classification with more than one housing unit within the same building. Examples are two-family homes or large apartment complexes with dozens or even hundreds of units.
Some multi-unit properties have commercial space on the ground floor or in a separate building on the same property.
It’s crucial to note that not every multi-unit building is a multifamily property. For instance, residential occupancies that are not considered homes, including hotels and boarding homes, are multi-units but not necessarily multifamily since they have no separate kitchens and other facilities required by typical “families.”
2. Apartment Building
An apartment building is a real estate property containing more than one dwelling unit with independent cooking and bathroom facilities.
Apartment buildings and multifamily properties are often used interchangeably. The only key difference is that apartment buildings are one of the many types of multifamily properties.
3. Duplex
A duplex home is a small multifamily building with two connected dwellings with separate entrances within one property. In other words, a duplex house is a residential building with two housing units attached either side-by-side or one above the other.
4. Commercial Real Estate (CRE)
Commercial Real Estate (CRE) is a property established for business purposes or to generate rental income rather than a personal living space. This includes office buildings, retail outlets, warehouses, industrial parks, and hotels.
Multifamily properties and apartment complexes are considered commercial real estate since they are built for business purposes, specifically for generating rental income from multiple residential units within the same building or complex. Investors, lenders, and real estate professionals typically classify multi-unit properties as commercial real estate.
5. Investment Property
An investment property in real estate is purchased by a single investor or group of investors to generate income or to appreciate over time. The primary objective of an investment property is to generate Return On Investment (ROI) for the owner rather than to serve as a primary residence or personal use.
Investment properties come in different classifications: residential, commercial, and mixed-use. Residential investment properties include single-family homes, duplexes, triplexes, and apartment buildings rented out to tenants to generate income.
Commercial investment properties include retail spaces, office buildings, warehouses, and industrial parks used for business purposes and to generate rental income or capital gains for real estate investors.
Mixed-use properties are buildings that serve a combination of residential and commercial purposes. Examples are properties with apartments on the upper floors and retail or office space on the ground floor.
Key Multifamily Real Estate Investing Terms
6. Return On Investment (ROI)
Return on investment (ROI) is the ratio between net income and real estate investment. In other words, ROI describes the profit you made in relation to the capital you invested in a real estate property. It can be seen as a performance measure that evaluates the efficiency of an investment or compares the efficiencies of different investments
Return On Investment = Net Income divided by the Total Investment) x 100.
7. Cap RateThe capitalization rate, or cap rate, is one of the most widely-used metrics for estimating the yiel...
Cap Rate (capitalization rate) calculates the potential profitability of an investment property. You can determine your cap rate by dividing your property’s net operating income by its current market value. This metric typically projects the rate of ROI based on the income your property is expected to generate.
While the cap rate is quite helpful in quickly comparing the relative value of similar real estate investments in the market, it should not be the only indicator of an investment’s strength. Why? Because it doesn’t consider factors like leverageThe process of using debt as a funding source in real estate financing, usually as a strategy to pur..., the time value of money, and future cash flows from property improvements, among others.
Cap Rate = Net Operating Income/Property Value.
8. Replacement Reserve
A replacement reserve is an account funded by property owners to deal with major long-term repairs and unexpected expenses.
This fund can be used to replace major components of a property, such as HVAC systems, roofing, and parking lots. It also covers unexpected expenses like insurance deductibles, legal fees, or remediation costs. By setting aside funds in a replacement reserve, property owners can guarantee that they have the necessary resources to maintain and repair their property in the long run, which can help protect the value and profitability of the investment.
9. Net Cash Flow
Net cash flow in real estate is the amount of cash generated by an investment property that is available to the owner or investor after paying all operating expensesOften referred to as “OpEx,” operating expenses refer to all costs necessary to operate and main..., debt service, and taxes.
Rental property investors commonly measure net cash flow monthly and annually to track the inflows and outflows of money over a fixed period and evaluate the investment’s profitability and financial performance.
10. Preferred Return
Preferred return in real estate investing is a guaranteed return on investment a specific investor must receive before other investors within the team receive any profits.
Preferred return is typically offered to investors in a real estate partnership or syndication. Where it applies, it is generally between 6% and 9%, depending on the investment risk.
For instance, if an investor makes a $50,000 investment in a real estate partnership with a preferred return of 8%, they would receive $4,000 per year before any other profits are distributed to other investors.
11. Capital Expenditures (CAPEX)
Capital expenditures (CAPEX) are funds spent on physical assets, including repairing, maintaining, improving, or upgrading a real estate property to enhance its functionality or market value. Capital expenditures are usually channeled to large, durable items like roofs, HVAC systems, building envelopes, parking lots, and other critical structural components of a building.
12. Cash On Cash Return
A cash-on-cash (COC) return is a metric used in real estate transactions to evaluate the cash income made on a cash investment in a property. You can calculate COC return by dividing the annual pre-tax cash flow by the total cash invested.
Cash on Cash Return = Annual Pre-Tax Cash Flow / Total Cash Invested
13. Real Estate Investment Trust
A Real Estate Investment Trust (REIT) is a publicly traded company that owns, operates, or finances income-producing real estate properties.
Since REITs are modeled after mutual funds and pool the capital of numerous investors, they offer an excellent opportunity to those looking to invest in real estate without owning any physical property. Instead, such investors purchase shares in the REIT, which entitles them to a portion of the income generated by the properties held by the REIT company. It’s noteworthy that REITs are required to distribute a minimum of 90% of their taxable income to shareholders in the form of dividends.
14. Rent RollA register of rents that includes the names of tenants and amounts due, including any rent in arrear... (RR)
A rent roll is a document that a multifamily property investor, property manager, property management company, or lenderThe person or party (such as a bank or corporate entity) that loans money on a commercial real estat... uses to capture the income stream from a rental property.
A multifamily property rent roll typically includes details about each unit’s monthly rent, lease terms, and the tenants occupying the units. Rent rolls can be instrumental in analyzing a property’s financial performance, projecting future income, and identifying potential issues with tenants or leases.
15. Vacancy Rate
The Vacancy Rate is the percentage of all the available units in a real estate property that are unoccupied at any given time. Multifamily investors use this metric to investigate the health of a real estate property, especially in comparison to similar properties in the same neighborhood.
To calculate a property’s vacancy rate, multiply the number of vacant units by 100 and divide the result by the total number of housing units.
A low vacancy rate usually indicates that the property is in good shape and attractive to tenants, while a high vacancy rate means the opposite in most cases.
The ideal vacancy rate depends on several factors, such as the type of property, the location, and the local market conditions.
16. Occupancy Rate
The occupancy rate is the exact opposite of the vacancy rate. Both metrics are typically used together to provide a more comprehensive picture of a property’s performance. An occupancy rate is the percentage of rental units in a real estate property or market currently occupied by tenants at a given time. In other words, it is the ratio of rented housing units to the total number of available units.
For analysts, a high occupancy rate usually suggests a desirable, in-demand property, while a low occupancy rate usually means the opposite. Some factors affecting occupancy rate include location, property type, affordability, property condition, or market conditions.
To get your occupancy rate, divide the number of occupied units by the total number of units in your property or market and multiply the outcome by 100 to express in percentage.
17. Accredited Investor
An accredited investor is an individual or organization that meets specific requirements (including income, net worth, asset size, or professional experience) set by the Securities and Exchange Commission (SEC). By meeting these criteria, they are deemed to have substantial knowledge and experience to delve into certain types of private investment opportunities with higher risks and lower liquidity. The accreditation criteria typically include an annual income of at least $200,000 (or $300,000 for joint income) for the past two years or a net worth of at least $1 million, excluding primary residence.
18. Sophisticated Investor
A sophisticated investor is an individual or organization with a high level of knowledge, capital, and expertise to engage in advanced investment opportunities. In the real estate context, a sophisticated investor deeply understands the real estate market, including trends, risks, and potential rewards.
Unlike accredited investors, defined by specific financial criteria set by the Securities and Exchange Commission, the term “sophisticated investor” is not defined by any law or regulatory agency.
19. Economic Occupancy
Economic occupancy considers the actual rental income generated by a property, which may include discounts, concessions, or other factors that affect the effective rent. Economic occupancy provides a more accurate measure of a property’s performance than physical occupancy, which only considers the number of units occupied.
An economic occupancy rate measures the physical occupancy against the total possible income if the property is 100% occupied and tenants are paying the full market value in rent. Simply put, this real estate metric considers what a rental property is making against what it should be making.
You can calculate the economic occupancy rate by dividing the actual rental income generated by the property by the total potential rental income to be received if all units were rented at the full market rate.
Multifamily Loan Terms
20. Amortization
Amortization is the act or process of paying off a loan over a period through a series of regular installments, including principal and interest. The amount of each payment is determined by the loan amount, interest rate, and length of the loan term.
The amortization schedule typically starts with a higher proportion of interest payments and a lower proportion of principal payments. It gradually shifts over time until the final payment consists almost entirely of the principal.
21. Amortization Period
The amortization period is the time frame required to fully pay off a loan through regular (monthly) payments that include both principal and interest. A longer amortization means a lower monthly payment.
22. Fully Amortizing Loan
A fully amortizing loan is when a borrower makes regular payments over the entire loan term, resulting in the loan being fully paid off by the end of the term.
23. Comparables (Comps)
Comparables (Comps) are used by real estate appraisers, agents, and investors to measure the fair market value of a property based on recent sales of similar properties in the same market. These similarities may be in terms of location, size, age, condition, and other relevant factors that can impact property value.
24. Equity
Equity is capital an investor offers, which lenders require as part of the total funding sources.
25. Fixed Rate
A fixed interest rate remains unchanged during the loan term.
26. Variable Rate
A variable interest rate fluctuates during a loan term.
27. Debt Service Coverage Ratio
Debt Service Coverage Ratio (DSCR)The DSCR is a tool used to underwrite a loan secured by an income producing property. The ratio is c... is a financial ratio that measures the ability of a property to generate enough income to cover its debt obligations. It measures the ratio of net operating income (NOI)The revenue a property earns minus operating expenses, vacancy, and uncollectible receivables. The n... to the property’s annual debt serviceThe amount required to be paid by a borrower each year to cover scheduled principal and interest on ... (ADS) payments.
Although no industry standard exists, a DSCR of at least 2 is generally considered very strong. Many lenders will set minimum DSCR requirements between 1.2 and 1.25, provided the borrower meets the lender’s other underwriting requirements.
DSCR = Net Operating Income / Annual Debt Service
28. Debt Service Reserve (DSR)
The Debt Service Reserve is an account set aside by a borrower (usually at the lender’s request) to ensure that the borrower can repay the debt should any unforeseen circumstances result in a shortfall in cash flow.
29. Interest Only (IO) Period
An Interest Only (IO) Period is a time frame a borrower can only make interest payments on a loan without any fees toward the principal amount borrowed.
30. Loan-to-Value Ratio
Loan-to-Value Ratio (LTV) expresses the ratio of a loan amount to the appraised value or purchase price of a property. It is commonly used in real estate financing to evaluate the risk of a loan and determine the maximum amount a lender can lend and the minimum amount a borrower can provide as a down payment.
Determining an LTV ratio is a critical aspect of mortgage underwriting. A higher LTV means that the borrower has less equity in the property and has a higher chance of defaulting should there be a sharp drop in the property’s value. This means that the higher the LTV, the higher the loan risk.
Let’s say a property is appraised at $100,000, and a borrower wants a loan of $80,000; the LTV ratio will be 80%.
31. Affordability
Affordability in real estate is the ability of potential buyers or renters to pay for a property or a housing unit without experiencing financial difficulty.
The relationship between rent and household income determines affordability. If the rent of a property is too high compared to the income of the potential buyer or renter, the property may be deemed unaffordable.
Other factors like interest rates, property taxes, utility costs, and changes in household income or expenses over time can influence a property’s affordability.
32. Agency Lender
An agency lender is an organization that finances real estate projects on behalf of a government-sponsored enterprise (GSE) like Fannie Mae or Freddie Mac. Multifamily investors prefer agency lenders since they typically offer a wider range of financing options and more favorable terms than non-agency lenders.
33. Government-Sponsored Enterprise (GSE)
A Government-Sponsored Enterprise (GSE) is a quasi-governmental organization operating as a private enterprise. It was created by Congress to ramp up credit flow in some regions of the United States economy. Examples of GSEs are Fannie Mae and Freddie Mac, established to ensure the availability and affordability of multifamily loans for US families. Fannie and Freddie buy mortgages from lenders, providing liquidity in the mortgage market and freeing up capital for new mortgages.
34. Guarantor
A guarantor is a person or entity that guarantees to pay off a real estate financing debt if the borrower or obligor fails to meet the deadline. The guarantor is essentially co-signing the loan or contract and is legally bound to honor the terms of the agreement if the primary borrower defaults.
35. Lender
A lender is a financial institution approved by Fannie Mae, Freddie Mac, or both to provide multifamily loans for purchasing or refinancing a real estate property.
Operational Terms For Commercial Real Estate
36. Net Rental Income (NRI)
Net Rental Income (NRI) represents the rental income received by a property owner after deducting all the expenses associated with owning and operating the property. NRI is essential for real estate investors to evaluate their rental properties’ profitability and make informed decisions about managing and financing their real estate property investment.
37. Net Operating Income (NOI)
Net Operating Income is the difference between a rental property’s income and its operating expenses. These operating expenses don’t include capital expenditures and debt service payments.
NOI = Gross Rental Income – Operating Expenses
38. Operating Expenses
Operating expenses are ongoing costs of managing and maintaining a rental property. These expenses include fees to keep the property in good condition, operational, and profitable.
39. Gross Income
This refers to a residential property’s total income before any expenses are deducted.
Legal Terms for Multifamily Investing
40. Fair Housing Act
Passed as part of the Civil Rights Act of 1968 by the 90th United States Congress, the Fair Housing Act was a game-changer in the United States real estate industry. It prevents citizens from any housing-related discrimination.
The Fair Housing Act encompasses selling, buying, renting, or refinancing a home. It also applies to getting a housing loan and seeking housing assistance. It was amended in 1988 to include protections for people with disabilities and households with children.
41. Security Deposit
A security deposit is any money given to a property owner at the beginning of a lease to cover any damages a tenant could cause to the property during their occupancy. Security deposit also covers any unpaid rent or minor fees a tenant may owe at the end of their stay.
42. Lease Agreement
A lease agreement (or rental agreement) is a legal contract between a landlord and a tenant outlining the terms and conditions of the rental arrangement. Examples include the length of the lease, rent payment details, security deposit, utilities, maintenance responsibilities, and other terms that govern the tenant-landlord relationship.
Multifamily Real Estate Market Terms
43. Fair Market Value (FMV)
In real estate, FMV refers to the price a property would sell for in an open market if offered for sale in a reasonable period and if the buyer and seller have all the necessary information about the property.
44. Absorption Rate
The absorption rate measures how quickly available properties are sold or leased during a specific period in a given market. It calculates the demand for real estate in a particular neighborhood in relation to the supply.
45. Comparative Market Analysis
A Comparative Market Analysis (CMA) is a strategy to estimate the current market value of a real estate property by comparing it to similar ones that were recently sold or are currently for sale in the same neighborhood.
How Leap to Loans Can Help You
We aim to walk you through your multifamily real estate investment journey while offering you the relevant tools and market intelligence to help ensure a seamless process. Our quote tool allows small-balance investors to instantly obtain quotes for multifamily loans and start investing right away!
Frequently Asked Questions
What is IRR Multifamily Real Estate?
Internal Rate of Return (IRR) estimates the rate of return a property is expected to generate over the holding period, considering both the cash inflows and outflows associated with the investment. An IRR between 12% and 15% is widely accepted for a multifamily deal.
Is it Multi-Family or Multifamily?
Both words are widely used as far as the real estate industry is concerned. However, “multifamily” is more acceptable in the United States as a single word to describe properties containing more than one housing unit.
What is Class A Multifamily?
Class A multifamily is a category of high-end, luxury apartments typically offering high-quality amenities, finishes, and maintenance. These properties are newer, professionally managed, and set aside for high-income earners. They are usually located in highly sought-after neighborhoods with low vacancy rates.
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