Capitalization Rate (Cap Rate)

A capitalization rate (or "cap rate") is a measure of the ratio between the cash flow produced by an asset (usually real estate) and its capital cost (the original price paid to own the asset) or alternatively its current market value. The rate is calculated in a simple fashion as follows:

For example, if a building is purchased for $1,000,000 sale price and it produces $100,000 in positive net cash flow (the amount left over after fixed costs and variable costs are subtracted from gross lease income) during one year, then:
$100,000 / $1,000,000 = 0.10 = 10%
The asset's capitalization rate is ten percent.

Note that in real estate appraisal in the U.S., a stylized measure of cash flow is used, called net operating income. It is essentially the same as net cash flow, except that debt service and income taxes are not included while a reserve for replacements is included. In real estate investment, real property is often valued according to projected capitalization rates used as investment criteria. This is done by algebraic manipulation of the formula above:

For example, in valuing the projected sale price of an apartment building that produces an annual net cash flow of $10,000, if we set a projected capitalization rate at 7%, then the asset value (or price we would pay to own it) is $142,857.
This is often referred to as direct capitalization, and is commonly used for valuing income generating property in a real estate appraisal.

One advantage of capitalization rate valuation is that it is separate from a "market-comparables" approach to an appraisal (which only compares what other similar properties have sold for based on a comparison of physical characteristics). Given the inefficiency of real estate markets, multiple approaches are generally preferred when valuing a real estate asset. Capitalization rates for similar properties, and particularly for "pure" income properties, are usually compared to ensure that estimated revenue is being properly valued.

Yield

In Europe, the term Yield is more frequently used in connection with real estate than capitalization rate. Yield is a more general term that refers to (gross) income in relation to the price of an asset. The rate is calculated in a simple fashion as follows:

(see also its inverse - GRM Gross Rent Multiplier)

Net Operating Income NOI
Earnings before interest and taxes EBIT

In financial and business accounting, earnings before interest and taxes (EBIT) is a measure of a firm's profitability that excludes interest and income tax expenses.

Operating income is the difference between operating revenues and operating expenses, but it is also sometimes used as a synonym for EBIT and operating profit. This is true if the firm has no nonoperating income.

To calculate EBIT, expenses (e.g., the cost of goods sold, selling and administrative expenses) are subtracted from revenues.
Profit is later obtained by subtracting interest and taxes from the result.

Statement of Income — Example (figures in millions)

Earnings before interest, taxes, depreciation and amortization EBITDA

is a non-GAAP metric that can be used to evaluate a company's profitability.

Its name comes from the fact that Operating Expenses do not include interest, taxes, depreciation or amortization. EBITDA is not a defined measure according to Generally Accepted Accounting Principles (GAAP), and thus can be calculated however a company wishes. It is also not a measure of cash flow.

EBITDA differs from the operating cash flow in a cash flow statement primarily by excluding payments for taxes or interest as well as changes in working capital. EBITDA also differs from free cash flow because it excludes cash requirements for replacing capital assets (capex). EBITDA is used when evaluating a company's ability to earn a profit, and it is often used in stock analysis.

Revenue Per Room RevPAR

RevPAR, or revenue per available room, is an important metric relevant to the hotel industry. Often it is utilized as a primary statistic indicating the overall financial performance of a property. RevPAR numbers represent a measure of performance in terms relative to a property's past results, and especially in comparison to competitors within a custom defined market, trading area, or DMA (Designated Market Area). Also, comparisons are usually best considered between hotels of the same type, or with target customers. (e.g. Full Service, Luxury, Extended Stay, Economy). A few syndicated data companies compile RevPAR information across markets via voluntary survey, and provide compiled blinded information back to the industry.

• Successful RevPAR numbers differ from market to market based on demand, cost of living, and other factors.
  
• Best compared across like time periods. For example, it is proper to compare RevPAR on a Friday only versus other Fridays.
  
• Best compared across similar seasonal time periods. For example, comparing results from the Christmas week with the same a year previous is more credible than with a non-holiday week.

• RevPAR is revenue per available room,
  
• A is the ADR (average daily rate), the average price per room sold,
  
• O% is the rate of occupancy, or % of rooms sold.

RevPAR evaluates the strength of only one type of revenue-generating stream, and it is important to note that many hotels derive a substantial portion of their total revenues from restaurants, golf courses, spas, casinos, business conferences, and other amenities. Therefore, one must also consider these other revenue streams in addition to comparing RevPAR ratios among companies.

Gross Rent Multiplier GRM

Gross Rent Multiplier is the ratio of the price of a real estate investment to its annual rental income before expenses such as property taxes, insurance, and even utilities for vacation rental properties. Other expenses could include the cost of hiring a property management company. Gross Rent Multiplier, it is the number of years the property would take to pay for itself in gross received rent.

For the investor, a higher GRM (perhaps over 20) is a poorer opportunity, whereas a lower one (perhaps under 15) is better.

The GRM is useful for comparing and selecting investment properties where depreciation effects, periodic costs (such as property taxes and insurance) and costs to the investor incurred by a potential renter (such as utilities and repairs) can be expected to be uniform across the properties (either as uniform values or uniform fractions of the gross rental income) or insignificant in comparison to gross rental income. As these costs are also often more difficult to predict than market rental return, the GRM serves as an alternative to a measure of net investment return where such a measure would be difficult to determine.

The common measure of rental real estate value based on net return rather than gross rental income is the Capitalization Rate or Cap Rate. In contrast to the GRM, the Cap Rate is not a multiplier but a rate of annual return. A similar multiplier to the GRM derived from net return would be the multiplicative inverse of the Cap Rate.

Market Value

Market Value is the price at which an asset would trade in a competitive Walrasian auction setting. Market Value is usually interchangeable with Open Market Value or Fair Value. International Valuation Standards (IVS) define Market Value as:

Market Value is the estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arms-length transaction after proper marketing wherein the parties had each acted knowledgably, prudently, and without compulsion.

Market Value is a concept distinct from market price. The concept is most commonly invoked in inefficient markets or disequilibrium situations where prevailing market prices are not reflective of true underlying market value. For market price to equal market value, the market must be informationally efficient and rational expectations must prevail.

The term is commonly invoked in real estate appraisal, since real estate markets are generally considered both informationally and transactionally inefficient. Also, real estate markets are subject to prolonged periods of disequibrium, such as in contamination situations or other market disruptions.

Appraisals are usually performed under some set of assumptions about transactional markets, and those assumptions are captured in the definition of value used for the appraisal. The most common definition of value used for real estate appraisals in the U.S. is referred to as market value, fair market value, or sometimes true market value. Commonly, the definition set forth for U.S. Federally regulated lending institutions is used, although other definitions may also be used under some circumstances:

The most probable price (in terms of money) which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby: the buyer and seller are typically motivated; both parties are well informed or well advised, and acting in what they consider their best interests; a reasonable time is allowed for exposure in the open market; payment is made in terms of cash in United States dollars or in terms of financial arrangements comparable thereto; and the price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.

Net Present Value NPV

Net present value (NPV) is a standard method for the financial appraisal of long-term projects. Used for capital budgeting, and widely throughout economics, it measures the excess or shortfall of cash flows, in present value (PV) terms, once financing charges are met.

Internal Rate of Return IRR

The internal rate of return (IRR) is a capital budgeting method used by firms to decide whether they should make long-term investments.

The IRR is the annualized effective compounded return rate which can be earned on the invested capital, i.e. the yield on the investment.

A project is a good investment proposition if its IRR is greater than the rate of return that could be earned by alternative investments (investing in other projects, buying bonds, even putting the money in a bank account). Thus, the IRR should be compared to an alternative cost of capital including an appropriate risk premium.

Mathematically the IRR is defined as any discount rate that results in a net present value of zero of a series of cash flows. In general, if the IRR is greater than the project's cost of capital, or hurdle rate, the project will add value for the company.

As an investment decision tool, the calculated IRR should not be used to rate mutually exclusive projects, but only to decide whether a single project is worth investing in. In cases where one project has a higher initial investment than a second mutually exclusive project, the first project may have a lower IRR (expected return), but a higher NPV (increase in shareholders' wealth) and should thus be accepted over the second project (assuming no capital constraints). A method called marginal IRR can be used to adapt the IRR method to this case.

Leverage

Financial leverage takes the form of a loan or other borrowings (debt), the proceeds of which are reinvested with the intent to earn a greater rate of return than the cost of interest. If the firm's return on assets (ROA) is higher than the interest on the loan, then its return on equity (ROE) will be higher than if it did not borrow. On the other hand, if the firm's ROA is lower than the interest rate, then its ROE will be lower than if it did not borrow. Leverage allows greater potential return to the investor than otherwise would have been available. The potential for loss is also greater, because if the investment becomes worthless, the loan principal and all accrued interest on the loan still need to be repaid.

Margin buying is a common way of utilizing the concept of leverage in investing. An unlevered firm can be seen as an all-equity firm, whereas a levered firm is made up of ownership equity and debt. A firm's debt to equity ratio (measured at market value or book value, depending on the purpose of the analysis) is therefore an indication of its leverage. This debt to equity ratio's influence on the value of a firm is described in the Modigliani-Miller theorem. As is true of operating leverage, degree of financial leverage measures the effect of a change in one variable on another variable. Degree of financial leverage (DFL) may be defined as the percentage change in earnings (Earnings per share) that occurs as a result of a percentage change in earnings before interest and taxes.

Overage (Claw Back)

Overage (also called “claw back”) is a term to describe a sum of money in addition to the original sale price which a seller of land may be entitled to receive following completion if and when the buyer complies with agreed conditions. Overage can be a useful device for both buyers and sellers, allowing transactions to proceed on terms which are commercially acceptable to both parties but where current circumstances/valuations do not support the aspirations of one or both of them.

A typical scenario would be : On completion a Buyer pays £x for a piece of land and the Seller is aware of the Buyer’s intention to develop the land. Overage provisions are negotiated into the contract of sale to ensure that once planning is obtained, the Seller receives a proportion of the increase in the value of the land.

Mezzanine Financing

A hybrid of debt and equity financing that is is typically used to finance the expansion of existing companies. Mezzanine financing is basically debt capital that gives the lender the rights to convert to an ownership or equity interest in the company if the loan is not paid back in time and in full. It is generally subordinated to debt provided by senior lenders such as banks and venture capital companies.

Since mezzanine financing is usually provided to the borrower very quickly with little due diligence on the part of the lender and little or no collateral on the part of the borrower, this type of financing is aggressively priced with the lender seeking a return in the 20-30% range.

Mezzanine financing is advantageous because it is treated like equity on a company's balance sheet and may make it easier to obtain standard bank financing. To attract mezzanine financing, a company usually must demonstrate a track record in the industry with an established reputation and product, a history of profitability and a viable expansion plan for the business (e.g. expansions, acquisitions, IPO).

AAA Credit Rating

Standard & Poor's is a credit rating agency that issues credit ratings for the debt of corporations, be they public or private. It is one of several CRAs that have been designated a Nationally Recognized Statistical Rating Organization by the U.S. Securities and Exchange Commission.

S&P rates borrowers on a scale from AAA to D. Intermediate ratings are offered at each level between AA and CCC (i.e., BBB+, BBB and BBB-). For some borrowers, S&P may also offer guidance (termed a "credit watch") as to whether it is likely to be upgraded (positive), downgraded (negative) or uncertain (neutral).

Investment Grade

• AAA : the best quality borrowers, reliable and stable (many of them governments)
  
• AA : quality borrowers, a bit higher risk than AAA
  
• A : economic situation can affect finance
  
• BBB : medium class borrowers, which are satisfactory at the moment

Proof of Funds

A document that demonstrates that a person has the ability and funds available to use for a transaction. It usually comes in the form of a bank, security or custody statement. The purpose of the document is to ensure that the funds required for the transaction are obtainable and legitimate.

Non-Circumvention Non-Disclosure Agreement NCND

An agreement between two or more parties specifying that none of the parties will go around each other to transact directly with the originator of the transaction, nor will any of the parties disclose the particulars of the transaction covered by the agreement. The terms of the agreement normally include a specified period of time during which the agreement will remain in force, and make allowances for disclosure on the part of one party to the agreement with written permission from the other parties. NCND's are enforceable in civil court.

NCND's are used for any type of transaction in which an agent wishes to protect his commissions and contacts, or when proprietary information needs to be kept discreetly between agreeing parties.

Incoterms (International Commercial Terms)

Incoterms deal with the questions related to the delivery of the products from the seller to the buyer. This includes the carriage of products, export and import clearance responsibilities, who pays for what, and who has risk for the condition of the products at different locations within the transport process. Incoterms are always used with a geographical location and do not deal with transfer of title.

Incoterms or international commercial terms are a series of international sales terms that are widely used throughout the world. They are used to divide transaction costs and responsibilities between buyer and seller and reflect state-of-the-art transportation practices. They closely correspond to the U.N. Convention on Contracts for the International Sale of Goods and are devised and published by the International Chamber of Commerce (ICC).

• EXW. Ex Works (named place): the seller makes the goods available at his premises.
  

• FCA. Free Carrier At (named place): the seller hands over the goods, cleared for export, into the custody of the first carrier (named by the buyer) at the named place. This term is suitable for all modes of transport, including carriage by air, rail, road, and containerised / multi-modal transport.
  
• FAS. Free Alongside Ship (named loading port): free Alongside Ship: the seller must place the goods alongside the ship at the named port. The seller must clear the goods for export; this changed in the 2000 version of the Incoterms. Suitable for maritime transport only.
  
• FOB. Free On Board (named loading port): the classic maritime trade term, Free On Board: seller must load the goods on board the ship nominated by the buyer, cost and risk being divided at ship's rail. The seller must clear the goods for export. Maritime transport only.
  

• CFR. Cost and Freight (named destination port): seller must pay the costs and freight to bring the goods to the port of destination. However, risk is transferred to the buyer once the goods have crossed the ship's rail. Maritime transport only.
  
• CIF. Cost, Insurance and Freight (named destination port): exactly the same as CFR except that the seller must in addition procure and pay for insurance for the buyer. Maritime transport only.
  
• CPT. Carriage Paid To (named place of destination): the general/containerised/multimodal equivalent of CFR. The seller pays for carriage to the named point of destination, but risk passes when the goods are handed over to the first carrier.
  
• CIP. Carriage and Insurance Paid to (named place of destination): the containerised transport/multimodal equivalent of CIF. Seller pays for carriage and insurance to the named destination point, but risk passes when the goods are handed over to the first carrier.
  

• DAF. Delivered At Frontier (named place)
  
• DES. Delivered Ex Ship (named port)
  
• DEQ. Delivered Ex Quay (named port)
  
• DDU. Delivered Duty Unpaid (named destination place)
  
• DDP. Delivered Duty Paid (named destination place)

Cost, Insurance and Freight CIF

Cost, Insurance and Freight (CIF) is a common term in a sales contract that may be encountered in international trading when ocean transport is used.

When a price is quoted CIF, it means that the selling price includes the cost of the goods, the freight or transport costs and also the cost of marine insurance. CIF is an international commerce term (Incoterm).

CIF is identical in most particulars with Cost and Freight (CFR), and the same comments apply, including its applicability only to conventional maritime transport. In addition to the CFR responsibilities, the seller under CIF must obtain in transferable form a marine insurance policy to cover the risks of transit with insurers of repute. The policy must cover the CIF price plus 10 per cent and where possible be in the currency of the contract. Note that only very basic cover is required equivalent to the Institute "C" clauses, and buyers should normally insist on an "all-risk" type of policy such as that under the Institute "A" clauses. The seller's responsibility for the goods ends when the goods have been delivered on board the shipping vessel. In the guidelines for CIF published in Incoterms 2000 the term "carrier" does not appear and it clearly states "the seller must deliver the goods on board the vessel at the port of shipment" which makes CIF the incorrect term to use where the seller wishes their responsibility to end when they deliver the goods into the hands of a carrier prior to the goods passing the ship's rail at the port of loading. In the great majority of transactions the more correct term is CIP. This term is only appropriate for conventional maritime transport, not ro/ro or international container movements.

Delivered Duty Unpaid DDU

Delivered Duty Unpaid (DDU) is an Incoterm. It means that the seller delivers the goods to the buyer to the named placed of destination in the contract of sale. The goods are not cleared for import or unloaded from any form of transport at the place of destination. The buyer is responsible for the costs and risks for the unloading, duty and any subsequent delivery beyond the place of destination.

However, if the buyer wishes the seller to bear cost and risks associated with the import clearance, duty, unloading and subsequent delivery beyond the place of destination, then this all needs to be explicitly agreed upon in the contract of sale.

The term is used irrespective of the mode of transport. However when the delivery is to take place at the port of destination, either on board the vessel or on the quay, then the terms DES or DEQ shall be used.

Commodity Purchase Procedure

1- The buyer sends Letter of Intent (LOI) or Irrevocable Corporate Purchase Order (ICPO).

2- The Seller sends Full Corporate Offer (FCO) to the Buyer.

3- The Buyer sends back countersigned FCO in acceptance of general terms and conditions.

4- The Seller sends the Draft Contract to the Buyer.

5- The Buyer signs and returns the Draft Contract, within 72 hours, to the Seller.

6- The Seller reviews changes, if any made, in the Draft Contract by the Buyer.

7- If the Seller agrees to the changes made by the Buyer the Seller sends via fax or email, signed Definitive Contract to the Buyer, who returns it countersigned.

8- Within 7 (seven) banking days after the final hard copy contract signature, the seller’s bank asks for the Banking Capacity Letter (BCL) from buyer’s bank.

9- Once seller receives the BCL in his bank, he provides the Proof Of Products (POP) confirmed by the seller’s bank in charge of the commodity.

10- Once the buyer receives the POP accepted by his bank, he will open and provide the irrevocable, divisible, transferable Letter of Credit (LC) to the seller’s bank.

11- The seller will issue a performance bond of 2% of the monthly value of the contract.

12- Parties exchange by Swift, bank to bank.

13- Inspection and delivery shipment shall after the fulfilment of the procedure, stated above, as per the terms and conditions of the contract and in according with schedule of deliveries.