Real Estate Crowdfunding Terms
What is IRR? what about Cap-rate? what do they mean by cash-on-cash? and what about Target Returns...
A wise man knows the value of a house, a wiser man knows the value of the fine prints
Author Name: No one you really know, we just made this up!
Jargons and terms you want to know when investing in real estate
Now that you've decided to invest in real estate syndication, here are the terms that you want to familiarize yourself with to better understand the digital and tradeable world of real estate investment: Crowdfunding, Tokenization, Fractionalization, Real Estate NFTs, and anything related to making real estate a more accessible and efficient investment opportunity.
Accredited investors are like Tony Stark and Bruce Wayne, but you don’t have to be as wealthy as them to become an accredited investor, you just need to have stuff excluding your primary residence worth more than $1 million dollar and/or have a high annual income, like $200k/year or more. In fact, you may be able to prove your income faster than Bruce and Tony especially if Alfred Pennyworth and Pepper are not around to help them out. Regulators normally restrict access to some investments to those who are accredited investors in order to be eligible to invest in private offerings and ‘complex’ financial products, the idea is to protect those who are not ‘sophisticated investors’ from falling prey to risky investments. You don’t quality as an Accredited Investor? Don’t worry much, there are many new helpful regulations such as crowdfunding that enables you to invest in real estate even if you are like Robin without Batman…
The increase in value of a property over time, usually due to market conditions, renovations, or other factors. The value of Leila’s property in DIFC has increased from $900,000 to $1,250,000 over the past year, due to rising demand and a growing economy, but also due to Leila’s efforts in creating a digital twin of her apartment and making it available for potential buyers to view her apartment in an immersive metaverse-like experience. Now you don’t have to create a digital twin of your apartment to gain value appreciation, but why not...
An evaluation of a property's value based on factors such as location, size, condition, and recent sales data. It is important to evaluate the appraiser who is conducting the appraisal, so you need to appraise the appraiser to evaluate whether their appraisal should be trusted or not. Oh man, that was a tongue twister… We believe AI will eventually help you further trust the value provided in appraisal reports, as long as the AI is fed properly, we are not talking organic food, we are referring to correct and updated data.
Annualized Net Profit
The total expected net profit from an investment over the course of one year. If a property investment is expected to generate a net profit of $10,000 per year, which means the money left from revenues (rent) after paying off all expenses, then its annualized net profit would be $10,000. If a property investment generates a net profit of $10,000 per year, it's like finding money in your couch every 365 days. Who wouldn't want that?
An individual or entity that provides funding for a project, often in exchange for equity or other benefits.
An individual or entity that takes out a loan, often used to purchase or improve property. So if Sarah is in the market for a new home and decides to take out a loan for $800,000 to buy Leila’s apartment. The bank says, "No problem! You're approved." And Sarah says, "Awesome, I'm officially a homeowner and a borrower”
A type of investment where the buyer purchases a property specifically for the purpose of renting it out, with the expectation of receiving rental income and potential appreciation in property value. As an example, Mohammed from Abu Dhabi is a smart investor, always on the lookout for a good deal. He finds a crowdfunded property in California listed on one of the most trusted crowdfunding platforms in the US. The apartment is for $400,000 and the idea is to buy the apartment with the intention to rent it out. But Mohammed invests $10,000 only and receives a share of the investment (because he is smart remember, he is diversifying his real estate portfolio). Now he can sit back, relax and collect rent, like a king collecting taxes!
So you're ready to invest in real estate crowdfunding or tokenization and want to ensure you're choosing the right investment, huh? Well, one metric you might want to keep an eye on is the Cash-on-Cash return.
Also known as the cash yield or just yield, the Cash-on-Cash return is a way of measuring the performance of commercial real estate investments and can provide valuable insight into the likelihood of receiving regular cash distributions over the course of an investment.
To calculate the Cash-on-Cash return rate, simply divide the annual pre-tax cash flow by the total amount invested. For example, if you put $100,000 in the purchase of an apartment building and the annual pre-tax cash flow you receive is $10,000, then your Cash-on-Cash return is 10%. Bam! That's like a real estate investment karate chop!
But here's the thing, the Cash-on-Cash return only measures operational cash flow and doesn't consider any profits from capital events like a sale or refinance.
And here's a disclaimer, any forward-looking Cash-on-Cash return is targeted, not promised. If you are interested more in promised or more guaranteed returns, then investment in a real estate backed debt is your better choice, however you will be giving up on the potential upside but you minimize your downside. I know! Sometimes having too many choices makes your decision making more difficult…but hey, crowdfunding enables you to diversify, so you can do both? And it just takes minutes on online marketplaces or on our platform that enables you to connect to most trustworthy real estate crowdfunding platforms from all around the world, be it debt or equity.
However, despite the fact that it's just a target, the Cash-on-Cash return can still be a useful metric to estimate the distributions an investor might receive over the course of the investment period. It's like having a trusty sidekick by your side on your real estate investment journey!
Cooling off Period
A mandatory waiting period after a crowdfunded mortgage / loan or investment agreement is signed, during which the borrower or investor may cancel the agreement without penalty. This is mainly done to protect you from making an impulse decision that you may regret the next morning, just like the one you did in Vegas… so assume you were browsing listings in Dubai on Stake, Smart Crowd, AqarChain or some other real estate crowdfunding originator, and you had love at first sight with a Dubai Marina property with uninterrupted sea view (be careful, they often tend to find some land in front of that building which eventually will interrupt that view!), but anyway, let’s say you commit to some crowdfunded real estate deal, and sign the agreement but suddenly realize, "Wait a minute, what did I just sign?" Don't worry, you have a 3-day cooling-off period, enough time to catch your breath and cancel the agreement if needed.
Commercial Real Estate Investments Categories
There are four or five main categories of private equity real estate investments and they are all unique in their own way. The first one is "core", which is like the basic math class of investments - low risk, low returns. Then, there's "core-plus", which is like that math class with a little extra oomph - higher returns, a bit more risk.
Next up, we've got "value-added", which is like the home renovation show of investments. You invest a bit of effort (or money) to increase the net operating income (NOI) and target higher returns. We love value-add, that's where most of the fun and creative thinking go into making higher returns.
Then we have "opportunistic", which is like the extreme sports of investments - high risk, high returns. And if you're feeling extra adventurous, you can try "development", which is generally regarded as a subcategory of opportunistic investment, but we think it deserves a category on its own. After all, all existing real estate went through that phase of development first (except maybe the Pyramids of Egypt and possibly the Ruins of Baallback, possibly were beamed up (or down?) from another world).
Just remember, when it comes to investments, risk and return go hand in hand. And, like with any extreme sport, the success of a project depends on the expertise of the sponsor and their ability to execute a plan.
Class A, Class B and Class C
Commercial real estate is like a popularity contest in high school. Class A properties are the prom queens and kings, with their top-notch construction, design, and amenities. Meanwhile, Class C properties are the misfits who never quite made the cut. But, like high school, the popularity can change with renovations, tenant repositioning, and locale changes and market changes. Class B properties are like the popular jocks, always in demand no matter what the economic climate. So, whether you're a seasoned real estate investor or just starting out, don't overlook the steady and dependable Class B assets! Reason being is Class B generally have much more balanced tenant mix that can withstand cyclical downturns.
The ranking is important in determining a property's competitiveness, market value, and rents. The classification applies to all property types, and the grading criteria are based on factors such as construction quality, design, technology, and amenities
IRR (Internal Rate of Return), is a metric used to determine whether an investment opportunity is worth doing. It calculates the rate at which the present value of an investment's cash flows (initial investment, returns) equals zero. What does that mean? think of IRR as your annualized investment expected return rate over the investment horizon, so it takes in consideration time value of money as a major factor. If you want to know more and get confused, read on: it just means that it is a formula that looks at all investments made throughout the property investment cycle and all the profit and returns including the sale of the asset at the time they were each made, and guesses a percentage rate which if used to discount future cash flow to today's present, the net present value of this cash flow will be equal to zero. Ok, I think we are confusing you even more...
It's important to remember that just because an investment has a high IRR, it doesn't necessarily mean it will win the biggest trophy. Other factors such as the distribution schedule, cash-on-cash and business plan must also be considered before busting a move.
Target IRR is what the rate of return that Sponsor or the Crowdfunding Platform expects from their proposed property investment, based on their underwriting. Remember that Target IRR is not a promise nor a guarantee, and often double check how it is calculated, whether the cash flows took in consideration costs such as property and asset management fees and others, all of which are necessary to arrive at a true Target IRR.
Real Estate Equity Multiple
In real estate, the equity multiple is used as a measure of the total return received by an investor. It is the decisive test of an investment's success. If it's less than 1.0x, it's like your grandma's fruitcake - nobody wants it. It means you put more money than you are getting back… not cool But if it's greater than 1.0x, that’s when you made a good investment decision! cha-ching! For instance, an equity multiple of 3.50x means that for every $1 you invested, you're making $2.50, not too shabby! Just remember, the equity multiple is a snapshot in time and doesn't take into account the amount of time you had to hold your breath while waiting for the return, or the time value of money (which is like trying to put a value on your soul), you know inflation and other factors affect the purchasing power of your money.
An SPV, or Special Purpose Vehicle, is a legal entity created for a specific purpose or project. In the context of real estate crowdfunding and tokenization, an SPV is typically used to hold and manage a specific real estate asset or portfolio of assets.
The SPV is typically structured as a limited liability company or limited partnership, and is separate from the real estate crowdfunding or tokenization platform. This allows the assets to be held in a separate legal entity and protects the platform and its investors from liability.
Additionally, the use of an SPV allows the assets to be easily bought, sold, and traded, as they are held in a form that can be easily fractionalized and tokenized. This theoretically enhances liquidity and makes it easier for investors to buy and sell their investments in real-time.
The minimum amount you can invest in one share, token or fraction of a real estate equity or debt. Some crowdfunding and tokenization platforms divide the ownership interest in such a way to enable a $10 investment. So $10 would buy you a token representing a small economical ownership in the real estate. So when the Mandarin Oriental New York on Columbus Circle or one of your favorite hotels open up for tokenization, you can become the proud co-owner of some 0.00001% of that beautiful hotel, and you can post the following on your social media: "I own an investment in the Mandarin Oriental New York" which is a true statement - just don't mention the 0.00001% part!
Sarah wants to buy a pen for $30, she has only $10 in her pocket, that’s her equity. Luckily, she has many siblings, Mary, Adam, Rami and Ali. The siblings all pitch in, they each lend Sarah $5 however only after Sarah promises she pays the total sum $20 back to her siblings, plus she has to make them breakfast for the entire following week. In this example, Mary, Adam, Rami and Ali are the Crowds. They together ‘crowdfunded’ $20 ($5 each) to the benefit of their sister Sarah is now the Borrower. That’s it, simple no? In real estate, the pen is generally a property, and the debt is a mortgage or commercial loan. So just like equity, debt can also be crowdfunded.
Investing in crowdfunded debt gives you indirect exposure to real estate, it limits your downside in case of some unfortunate event like alien invasion but also prohibits your upside (the aliens may be friendly and need a place to live, so sudden demand increase means property appreciation!!!). If for example Sarah returns the entire $20 (initial principal amount) and makes her siblings breakfast, then all her siblings receive exactly what they were expecting: their $5 back and breakfast for a week (breakfast instead of loan interest), but they are unlikely going to also get lunch and dinner. Now there is still the risk of Sarah not paying back the initial principal amount, and may not even make breakfast every day: this is called a default on the debt / loan. Here it gets complicated, and the kids need to ask their parents to step in as a judge to figure out some sort of restructuring or work around… but it's worth it! After all, you never know when Sarah will be in the mood to whip up some pancakes or some mouth-watering knafeh!
We will continue building this glossary until we cover most relevant terms you need to know when investing in the property syndication industry