As regular readers are aware, periodically I take the time to throw out some words and phrases commonly used in the practice of real estate. It’s proven more popular than I initially imagined. Go figure. There’s no rhyme or reason, or even a particular order — just quick definitions for you to reference. Much of the real estate nomenclature, both in general, and investment oriented, has been either misunderstood, or unintentionally modified by misinformed word of mouth.
In any case, here’s a new batch for you. If you have any words or phrases you’d like included next time, let me know. Also, the pictures are in no way related to any of the definitions. I just liked them.
Note: BawldGuy Radio is coming soon.
Capital Expenditure — The cost of an improvement made to extend the useful life of a property or to add to its value, such as adding a room. The cost of repairing a property is not a capital expenditure. Capital expenditures are appreciated over their useful life; repairs are subtracted from income for the current year.
Debt Coverage Ratio (DCR) — A ratio used in underwriting loans for income producing property which is created by dividing net operating income by total debt service. Ratios of at least 1.10 are generally required with ratios of 1.20 and higher considered the norm when it comes to apartment properties of more than 4 units. A ratio of 1.0 denotes a ‘break even’ cash flow.
Contingency — A condition that must be met before a contract is legally binding. For example, income property purchasers often include a contingency that specifies that the contract is not binding until the purchaser obtains a satisfactory property inspection report from a qualified professional inspector.
Often, folks mistake what the removal of a contingency means. In most cases it doesn’t mean the act as occured, it means the transaction will continue to the closing without reference to the act mentioned in the contingency. The inspection of the property doesn’t have to happen — it might or it might not. Since the contingency has been removed, the inspection of the units is now irrelevant.
Time is of the Essence — A phrase that, when inserted in a contract, requires that all references to specific dates and times of day noted in the contract be interpreted exactly, in its absence extreme delays might be acceptable. Most contracts insert this in the boiler plate. It’s one of the fundamental factors in any real estate transaction. Take it literally — the other side will.
Escrow Payment — The portion of a borrower’s monthly payment that is held by the loan servicer to pay for taxes, hazard homeowners insurance, mortgage insurance, lease payments, and other items as they become due. Known as “impounds” or “reserves” in some states. California says impounds — most of the other states in which we do business say ‘escrow’.
Legal Description — Legally acceptable identification of real estate by government survey, metes and bounds, or recorded plat. Surprised to see ‘property address’ missing here? Don’t be. Addresses are for your Aunt Mable, or party invitations. Legal descriptions need to be unique. How many Maple streets can be found in the U.S.? How much wouldya bet against there being more than one 3443 Maple Street in a highly populated region? Exactly.
Private Mortgage Insurance (PMI) — Insurance premium paid by a borrower to protect lenders against losses from loans with loan-to-value ratios higher than 80%, default insurance for lenders. This is what makes many investor loans possible. It’s relatively cheap, and a cost of doing business. It’s always factored into operating expenses upon analyzing income properties when applicable.
Encumbrance — Any right to or interest in land that affects its value, including mortgage loans, unpaid taxes, easements, junior liens, or deed restrictions. A common misconception is that encumbrances only refer to loans. Again — any right to OR interest in land that affects its value. How ’bout a land lease? Ah, yeah, that’s the ticket.
I’ll stop here so your eyes won’t begin to migrate to the back of your head.
Meanwhile back at BawldGuy Ranch, if you’ve finally reached the point at which you deem yourself ready to commence a Purposefully Planned march to retirement — Please contact me.
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What about CYA? I’ve heard it used many times.
One of my all time favorites.
It’s why contracts are now 10 pages plus endless addenda instead of the one page without even one addendum when I sold my first home.