Glossary of Commercial & Private Lending Terminology
The most senior tranche of the first trust loan.
After Development Value.
A group of individuals, typically representatives of the major investors in a private equity or real estate fund, that advise the fund’s general partner on various operational decisions such as conflicts of interest, asset valuation, and in some instances, new investments.
Institutional asset class that includes investments in private equity, real estate, oil & gas, timberlands, distressed debt, and may include some varieties of hedge funds.
A formal process for establishing the market value of a property investment, typically encompassing three approaches to value: discounted cash flow analysis or capitalization of future cash flows (income approach); replacement cost analysis (cost approach) and analysis of recent sales of comparable properties (sales comparison approach). Appraisals are often conducted by third parties. In the United States the Appraisal Institute provides an MAI designation to professional appraisers who have passed its certification requirements.
[ B ]
The junior tranch of the first trust loan. It has similar features to a mezzanine loan.
Each percentage point of yield in bonds equals 100 basis points. Basis points also are used for interest rates. An interest rate of 5% is 50 basis points higher than an interest rate of 4.5%. Sometimes referred to as BPS, BIPS, and pronounced “bips”.
Comparing returns of a portfolio to the returns of its peers; in private equity, fund performance is benchmarked against a sample of funds formed in the same vintage year with the same investment focus.
When a limited partnership has been formed by several investors pooling their capital and then subsequently looks for investments; virtually all private equity funds, and the majority of private real estate funds, are blind pools.
Temporary financing between major funding rounds for a private equity investment.
Acquisition financing for mature companies incorporating many strategies and structures: small buyouts are fund sizes up to $500 million, medium buyouts from $500-1,000 million; large buyouts above $1,000 million.
[ C ]
For real estate investments, any rate of return used to convert income into value.
Profit sharing component of the general partners’ compensation in a private equity or real estate limited partnership where profits are typically split 80/20 between the limited and general partners, after return of capital.
Common feature with many private equity and real estate funds where once the general partner has achieved its preference rate of return, the general partner takes all subsequent distributions until they have received their share of the designated carried interest to date.
Closed End Real Estate Fund
A private real estate fund with a fixed fund size and a limited term, typically 8-15 years.
(Commercial Mortgage Backed Securities) Securitized form of commercial real estate debt in which multiple loans are placed in a pool, which typically secures multiple tranches of rated publicly traded bonds plus lower rated or unrated bonds with limited liquidity.
Investments alongside other partnerships in all types of private equity and private real estate, leveraging their due diligence, usually on a non-promoted basis; co-investment allocations lower the overall cost of private equity and real estate programs.
Limited partner’s obligation to provide a certain amount of capital to a fund as the fund requests it.
Total capital committed to a fund by both the limited and general partners.
Aggregate IRR across several funds where all cash flows are pooled as if from one investment, after which an IRR is calculated.
Commercial real estate first mortgage debt is generally broken down into two basic categories: (1) loans to be securitized (“CMBS loans”) and (2) portfolio loans. Portfolio loans are originated by a leader and held on its balance sheet through maturity. In a CMBS transaction, many single mortgage loans of varying size, property type and location are pooled and transferred to a trust. The trust issues a series of bonds that may vary in yield, duration and payment priority. Nationally recognized rating agencies then assign credit ratings to the various bond classes ranging from investment grade (AAA/Aaa through BBB-/Baa3) to below investment grade (BB+/Ba1 through B-/B3) and an unrated class which is subordinate to the lowest rated bond class.
Much like a Platform Build-up where a private equity investor would attempt to consolidate an industry through acquisition.
Core Real Estate Fund
A private real estate fund that targets investment in well leased and located institutional grade properties and utilizes modest levels of debt. Such funds have typically targeted 9-11% net internal rates of return with the objective of providing investors with stable, ongoing operating income plus modest appreciation.
Core Real Estate Funds
Private real estate funds that pursue a strategy of owning core real estate.
The contractual interest obligation a borrower covenants to pay to its lender.
Typically part of the cross default provisions. These allow the lender to pursue the “good asset” for collection purposes.
Refers to a loan on two or more assets. If the terms or performance hurdles of one asset/loan is in default, the other (performing loan) also goes into default.
[ D ]
These are secured by either a second lien or an assignment of partnership interests.
A property investment involving substantial new construction leading to the creation of a physical asset.
Purchase of senior or junior debt instruments of a property, property portfolio or a company, or trade credits of a company, when the borrower is in financial difficulty.
Cash or the value of stock disbursed to the limited partners of a private equity fund.
Private equity fund managers have a fixed investment commitment where inflows and outflows are at their sole discretion; timing of cash flows should be factored into the returns, since they are under the manager’s control, using a discounted cash flow method such as IRR. Theoretically, time-weighted and dollar-weighted returns should be the same. This is true only when you calculate a periodic return every time there is a cash flow in or out of the portfolio; thus the value of the portfolio must be assessed at every cash flow. Frequent asset valuations are possible in public equities where liquid secondary markets post constantly changing prices by the minute. Private equity portfolios are revalued quarterly, and thus cannot be re-priced at every cash inflow or outflow; however, even quarterly valuations are only estimates since a liquidity event is at an unspecific date in the future, and immediate liquidity is most likely not possible. The private equity industry therefore uses an IRR calculation, which is by definition dollar-weighted, as a more exact measure of returns. The AIMR specifies that private equity managers should present cumulative annual Net IRR since inception by vintage year, and that composite returns should be calculated on a pooled basis as if from one investment.
Plan for the actual transfer of funds from the limited partners’ to the general partners’ control — with most private equity and real estate funds, capital is called on an as-needed basis.
Private equity or real estate investment firm’s detailed research of the business or property, the management team, and other factors to insure their accuracy, completeness, and soundness; or the investigation and evaluation of a management team’s characteristics, investment philosophy, and terms and conditions prior to committing capital to a fund.
[ E ]
Fund investment strategy involving investment in companies whose business is operational but needs capital to hire employees, purchase equipment, develop products, and roll-out sales & marketing programs.
Unsecured financial products. The structure and terms are defined in the Partnership Agreement.
Sale of ownership or equity in a company or property investment either through a sale, at the maximum return possible, To a strategic buyer or a financial buyer, or in the case of a company, an IPO.
[ F ]
Fair Market Value
(FMV) For real estate investments, the cash price that might reasonably be anticipated in a current sale, after exposure to the open market for a reasonable period of time.
First Mortgage Financing
For real estate investments, the highest priority debt secured by a property.
Amount of capital committed by the limited and general partners of a fund.
Fund that invests in other private equity or real estate partnerships; diversifies investors’ allocation across fund managers, geography, size of fund, and type and stage of financing.
[ G ]
This clause gives the tenant the option to terminate the lease or gives the tenant the right to a reduction of rent, if other tenants go out of business or leave the premises. For example, if the prospective tenant is counting on an adjacent supermarket to bring in business, then there should be some provision made for the possibility that the supermarket closes or leaves the location.
IRR based upon the performance of the investments, not taking into account management fees or carried interest.
Development or expansion financing for mature companies.
[ H ]
Included in hard costs are all of the costs for the visible improvements; line items like grading, excavation, concrete, framing, electrical, carpentry, roofing, and landscaping. Another way to describe the hard costs is the “brick and mortar” expenses.
Amount of time an investment remains in a portfolio from initial financing to final liquidation.
[ I ]
The agreement between the mezzanine lender and the first trust lender which outlines the rights available to the mezzanine lender.
Return of a fund before the final termination date; specifically, the IRR calculated where the residual value of the fund is taken as the final cash outflow.
IPO (Initial Public Offering)
Sale or distribution of a stock of a portfolio company to the public for the first time.
IRR (Internal Rate of Return)
Standard return calculation methodology in private equity and real estate which is the discount rate that equates the net present value (NPV) of an investment’s cash inflows with its cash outflows, or the annual effective compounded rate of return — see Interim IRR.
[ J ]
Typical profile of private equity returns over the life of a partnership; IRR at the initial investment is 0%, then drops during drawdowns for fees, then trends upward with value creation, and finally plateaus as distributions are made and the fund is liquidated.
Joint Venture Partnership
Real estate investments in which an operator/developer teams with one or more financial partners to acquire and operate a property or a portfolio of properties.
[ K ]
[ L ]
Fund investment strategy involving financing for the expansion of a company whose initial sales results are encouraging, but needs additional capital to expand production and marketing.
LBO (Leveraged Buyout):
Fund investment strategy involving the acquisition of a product or business, from either a public or private company, utilizing a significant amount of debt and little or no equity.
Investor in a syndicate that works most closely with management and negotiates on behalf of the other investors for the price and terms of an initial investment in a company or property or a subsequent financing round.
The amount of cash flow allotted to go to the mezzanine lender or B note holder prior to the senior lender being repaid in full.
London Interbank Offered Rate
A term interest often quoted as a 1,3,6-month rate for U.S. dollars and is used as another benchmark in real estate mortgages, specifically those with floating interest rates that reset frequently.
Ratio of the current level of financing for a property investment to the cost basis for that investment.
Ration of the current level of financing for a property investment to the fair market value for that investment.
[ M ]
MBO (Management Buyout):
Private equity investor finances a management team to acquire control of a company from the former ownership group.
Term is used differently in the real estate, venture and buyout worlds: in real estate it refers to subordinated debt financing, usually collateralized by a specific property or a portfolio of properties; in venture, it refers to the equity financing round just prior to an IPO, or can also refer to mid or late-stage venture financing; in buyouts, it refers to subordinated debt financing, usually with attached warrants, of more mature, stable, cash flowing companies.
Junior debt, or subordinate debt. It is a separate loan, with separate documentation, secured by an assignment of partnership interests.
Used either in reference to the multiple of cost a particular investment achieved (see ROI), or in reference to company valuation as a multiple of various income statement parameters.
Fund investment strategy targeting portfolio companies at various stages of development; sometimes referred to as Balanced-Stage.
[ N ]
A nationally recognized index that tracks the total return for a diversified basket of core property investments located in the United States.
IRR of a portfolio or fund taking into account the effect of management fees and carried interest.
[ O ]
Open End Real Estate Fund
A real estate fund with a long term life during which new investors can be admitted on an ongoing basis, and existing investors can make contributions or withdrawals at their discretion. Open end funds typically re-invest all operating and capital cash flows, unless required to meet withdrawal requests.
A commercial property that is fully developed and is being operated to accommodate tenants.
Opportunistic Real Estate Funds
Real estate funds, typically structured as closed end limited partnerships, that target higher risk strategies such as development, re-development, lease-up of vacant space and distressed assets. Such funds usually use higher levels of leverage and have typically targeted net internal rates of return of 15-25%+.
[ P ]
Pari Pasu Equity
The general class of equity.
Where a private equity investor acquires a “platform” company that grows through acquisition either of competitors or through forward (downstream) or backward (upstream) integration along the supply chain; may also be known as Leveraged Build-Ups (LBUs) if significant leverage is used.
In vintage year benchmarking for private equity, the pooled IRR aggregates all funds’ monthly cash flows in a particular vintage year into one cash flow series, which is then used to calculate a vintage year return.
The order in which holders of structured debt get paid.
Minimum rate of return a fund or a particular investment must achieve before the general partner can begin participating in the carried interest; for a performing fund, it merely pushes out the date at which the general partner participation begins.
A senior class of equity
Professionally managed equity investments in the unregistered securities of private companies.
Private Equity Real Estate
Privately owned equity real estate investments that may be held directly or owned through participation in a professionally managed real estate fund.
The profit participation available to the sponsor or day to day operator.
When a mezzanine lender or B Note holder advances money to the A Note holder or senior lender to protect their position, in the event of default of a first trust loan.
[ Q ]
[ R ]
Real Estate Investment Trust
A corporate real estate ownership vehicle created by the U.S. tax code which allows for a direct pass through of property income and capital gains to the company’s shareholders provided that the company makes annual distributions equal to 95% of its taxable income and provided that its meets certain tests with respect to the composition of its shareholders.
Real Estate J-Curve
Profile of cumulative net distributions in a private real estate fund: cumulative investor contributions typically exceed fund distributions for the first several years in the life of a fund (investor multiple is less than 1.0X); as the fund matures, and commences liquidating investments, capital is returned to the investors; for successful funds the cumulative total of operating cash flow distributions and capital distributions grows over time to produce an acceptable multiple of invested equity.
Investment strategy offering partial liquidity to the ownership group of a company; recaps typically take place in founder/owner situations for estate and succession planning.
A property investment that entails the substantial renovation of an existing building, sometimes involving conversion of the property to a new use.
Value of the underlying investments in a private equity or real estate fund as reported by the general partner.
The remaining value of the equity in a fund, used to calculate interim performance before final fund liquidation; in other words, cash and other assets net of liabilities plus the reported value of the remaining investments.
Investments made in distressed or poorly performing companies, with the intent of initiating a recovery via financial restructuring.
Return of Capital
Getting your principal investment back.
Return on Capital
The yield or ROE on your principal investment.
ROI (Return on Investment)
Multiple of cost received on a particular investment at liquidation
[ S ]
These are typically terms that are more prevalent in residential financing. Seasoning refers to the amount of time that has elapsed since a deed transfer has been recorded on a property. Some lenders require a specific “seasoning period” to elapse before they will consider making a loan to finance a property. This was instituted to prevent unscrupulous property “flipping” in which investors would repeatedly refinance a property, extracting cash each time and then allow the property to go into foreclosure when it was no longer refinanceable.
Fund that purchases private equity limited partnership interests or real estate interests in the secondary market; diversifies investors across vintage years in addition to the other fund-of-funds diversification benefits outlined above; high current income component as mature fund interests are already in liquidation phase.
Market where securities can be bought and sold following their initial offering, e.g. the New York Stock Exchange or NASDAQ. There is no formal secondary market for private equity or private real estate; however, some firms have raised capital to become market makers, purchasing private equity partnership interests from the original limited partners in the secondary market.
Fund investment strategy involving investments in companies at the concept or idea stage who need financing to research market and concept feasibility — pre-operational financing of a new business.
The first trust debt. This gets paid first and is secured by a senior lien on the real estate.
The soft costs are the costs in a real estate project which you cannot visibly see. Soft costs include the architect’s fees, the engineering reports and fees, the appraisal fee, the toxic report fee, any government fees – including the plan check fee, the cost of the building permit, any assessments, and any sewer and water hook-up fees – plus the financial costs, such as construction period interest and loan fees.
Opportunities that don’t fit within an established category, usually targeting distressed companies.
A substantially leased property.
Debt with inferior liquidation privileges to senior debt in case of a bankruptcy; sub debt will carry higher interest rates than senior debt, to which it is subordinated, to compensate for the added risk, and will typically have attached warrants or equity conversion features.
Sharing of an investment among several private equity or real estate firms where the group is called the Syndicate.
[ T ]
A time-weighted return is determined by calculating the rate of return between two or more periods, multiplying those returns together geometrically, and then taking the geometric mean of the result. Example: [(1.15*1.20*1.25)1/3]-1 = 20% return. Time-weighted returns are an approximation of an IRR and are usually easier to calculate than the IRR. The term is a misnomer as it does not consider the time value of money, but rather produces a return that does not penalize fund managers for timing decisions; the calculation treats a dollar distributed today the same as a dollar distributed ten years ago. Time-weighting was created to overcome the fact that the public securities manager has no control over the timing of the cash flow into or out of his management by his clients due to liquid secondary markets. The investment manager’s performance is therefore measured strictly on the investment decisions they make, not on the timing of cash flows.
A Tenants In Common (TIC) agreement is used to establish the rights of people unrelated by marriage who own property together.
In structured finance, a tranche (which is pronounced like “ranch” with a T in the beginning and is often misspelled as tranch, traunch or traunche) is one of a number of related securities offered as part of the same transaction.
[ U ]
[ V ]
Policy guidelines to value the holdings in a fund: venture funds typically hold the value of their portfolio companies at cost pending a write-up based on an arm’s length transaction or a write-down due to impaired operations at the general partner’s discretion; buyout funds typically mark their portfolio companies to market based upon discounted comparable public multiples at the general partner’s discretion and usually under advisement of the advisory board; real estate funds typically mark their property investments to market using a third party on an internal appraisal process, usually under advisement of the advisory board.
Value Added Real Estate Fund
A marketing term used to describe a broad range of real estate funds that engage in active strategies to create value in their underlying property investments – development, re-development, lease-up of vacant space, etc. Such funds target a broad range of returns and typically use modest to high levels of leverage.
Financing and operational added-value for younger, start-up companies with high growth potential.
Year of fund formation and first drawdown of capital.
[ W ]
Option to purchase stock in a company, over a specified period of time and under preset conditions.
A description of who gets paid first. Those at the top of the waterfall receive their payments first.
Reduction in the value of an investment; usually done at the fund’s discretion.
Increase in the value of an investment.
[ X ]
[ Y ]
The yield is the total interest that will accrue on the transaction over time, which differs from the posted percentage rates due to compounded interest.
[ Z ]