Glossary of Real Estate Investing Terms
Scythian Real Estate is a privately held real estate fund that serves as a full-service real estate partner to sophisticated cannabis operators throughout the United States. The Scythian cannabis real estate fund currently includes 23 properties used primarily as dispensaries, with investors seeing steady returns via long-term lease agreements entered into by the cannabis operators.
Cannabis Real Estate & Investing Terms
Also known as the “cannabis effect,” a cannabis premium refers to the inflated costs of cannabis properties imposed by landlords who may be looking to take advantage of the limited real estate options available to cannabis businesses and who might have concerns about how federal marijuana laws will be enforced. Additionally, due to federal lending guidelines and the reduced availability of bank financing for cannabis properties, it is often necessary for cannabis businesses to pay entirely in cash and to pay off the mortgage when buying real estate for a dispensary.
Also known as the capitalization rate, cap rate indicates the expected rate of return on investment in a commercial real estate property. The cap rate is often determined by several factors, including supply, demand, and the type of property. Cannabis real estate assets tend to have a higher cap rate than other real estate assets because properties zoned for marijuana dispensaries may come with a “cannabis premium.”
When a property owner makes a permanent structural addition to the property, alters the property through a restoration, or adapts the property to a new use, the change might be considered a “capital improvement.” A capital improvement is not the same as merely making repairs to a property. In fact, certain conditions must be met for the structural change or restoration to be considered a capital improvement: (1) it must enhance the value of the property or prolong the property’s useful life, (2) it must be permanently affixed to the property such that removal of the addition would cause damage to the property, and (3) it must be a permanent installation that endures for at least one year upon completion. In the context of cannabis real estate assets, it is common for property owners to adapt a commercial property for use as a cannabis dispensary or cultivation site.
A cash-on-cash yield, also known as a cash-on-cash return, is a calculation that estimates how much annual income will likely be earned on a property acquired in a commercial real estate transaction. Important factors in the calculation include the monthly or annual rent that will be collected, any operating expenses associated with the property, annual mortgage payments on the property, and the possibility that the property will remain vacant for some period of time. Real estate investors often use cash-on-cash yield to determine whether the expected ROI (return on investment) on a real estate acquisition will be worth the initial investment.
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. Investors often use EBITDA because it provides a true measure of a company’s profit potential before accounting decisions, financing structure, and deductions are factored in. Business owners often use EBITDA to compare one company’s financial performance against another company’s financial performance in the same industry. When determining exactly how profitable a particular company is, an investor may look to the company’s income statement and balance sheet for all the information needed to calculate EBITDA. A company’s EBITDA provides a good estimation of company cash flow because it focuses solely on core profitability.
EBITDAR stands for Earnings Before Interest, Taxes, Depreciation, Amortization, and Restructuring or Rent Costs. A company’s EBITDAR measures the company’s financial performance under certain conditions: when the company is being restructured (a one-time expense) or when the company has non-standard rent expenses (e.g., a restaurant or casino). EBITDAR is nearly identical to EBITDA, which also measures a company’s profit potential; the only difference is that EBITDAR adds the company’s restructuring expenses or rent expenses to the formula. A company’s EBITDAR can typically be calculated by using the company’s income statement and balance sheet. One type of business for which EBITDAR might provide a truer measure of core profit potential than EBITDA is a cannabis dispensary because dispensaries tend to have unique rent costs that include a cannabis premium.
A leaseback is a type of real estate deal in which a company sells a property to another party, and then the purchaser leases the property back to the company. Sale-leaseback transactions are a simple way for businesses to generate the funds needed for capital improvements or business expansion. Sale-leaseback agreements are common in the cannabis industry where cannabis operators are often unable to raise capital through bank financing because marijuana manufacturing and sales presently constitute a violation of federal law. Instead of receiving a loan from a bank, a cannabis operator can sell their property to a real estate fund and then commit to a long-term rental agreement for continued use of the property.
Liquidity is a term used in business, economics, and investment to mean the ease with which a company can convert its assets into cash at a fair market value. Some assets, such as stocks and bonds, are extremely liquid because they can quickly be sold at market value and converted into cash. Other assets, such as real estate and manufacturing equipment, are not very liquid because it may take a long time to convert them into cash. Liquidity is a particular problem for a lot of U.S. cannabis companies because cannabis remains illegal at the federal level, which means that banks will not provide financing to businesses operating in the cannabis industry. Without quick access to cash in the form of bank loans, cannabis operators may struggle to grow their businesses or expand their operations into new cannabis markets or territories. That is why a lot of cannabis operators rely on sale-leaseback deals in which the cannabis company sells its land, buildings, and other real estate assets to a real estate fund, and then the real estate fund leases the property back to the cannabis company at a favorable rate. This allows the cannabis business to access the money needed to make capital improvements to their existing properties and potentially expand their operations into other cities, states, or regions where cannabis is legal.
A net lease is a rental agreement between a landlord and a tenant in which the tenant is responsible for paying rent, utilities, and at least some portion of real estate taxes, building insurance fees, and building maintenance & repair costs. With a net-lease agreement, the tenant is effectively functioning as the property owner in that the tenant must pay for costs related to the property. The different types of net leases are single-net (N), double-net (NN), and triple-net (NNN). In a single net lease, the tenant pays for property taxes; in a double net lease, the tenant pays for property taxes and property insurance; and in a triple net lease, the tenant pays for property taxes, property insurance, and property maintenance costs. While gross leases are more traditional (with the tenant paying a set rental fee and the landlord covering all property expenses), net leases are common in commercial real estate agreements because they provide investors with a great deal of flexibility, a stable source of revenue, and minimal liability for property management. For investors in commercial real estate, single tenant net leases are the most desirable because the tenant is often required to commit to a long-term lease.
Net Operating Income:
Net operating income, or NOI, is a calculation that measures the profit potential of a commercial property. The NOI formula is the annual income generated by the property after deducting all the property’s operational expenses. Net operating income is an important factor used by investors to determine whether a particular piece of real estate will make a sound investment. Since the NOI formula is forward-looking, the analysis is typically based on either historical data for the commercial property or projections of how much income the property might generate in the future. Net operating income is solely about the ongoing income stream that will be produced by a rental property, so it does not take into account any financing costs, debt-related expenses, or capital expenditures.
A triple net lease, or NNN lease, is a rental agreement between a landlord and a tenant in which the tenant agrees to pay for most operating or property-related expenses in addition to rent and utilities. The three different types of expenses typically covered by an NNN lease are property taxes, building insurance, and maintenance costs. A triple net lease can be distinguished from a more traditional lease – e.g., a gross lease – in that the landlord is typically responsible for property expenses in a standard lease agreement. Triple net leases are common in the commercial real estate context, with the tenant making a long-term commitment while paying lower base rent charges. NNN leases are popular for commercial real estate investors because they offer a predictable, steady stream of income and minimal responsibility for additional expenditures for the duration of the lease.
Real Estate Limited Partnership:
A real estate limited partnership, or RELP, is a group of investors who collectively invest in properties and then sell or lease those properties. A general partner with experience in real estate development typically assumes liability and takes on the management responsibilities, while limited partners tend to function primarily as investors. RELPs can be a popular investment vehicle because they allow for long-term, passive investment in a diversified portfolio of properties with steady returns and high growth potential. RELPs also allow for tax deductions such as untaxed profits on the real estate. A RELP can be distinguished from a REIT (real estate investment trust) in that RELPs are funded through private equity and are not publicly traded.
A REIT, or real estate investment trust, is a company that owns and/or operates properties that generate income for investors. REITs typically raise capital for commercial real estate acquisitions from a group of individual investors, and those investors then earn income when the REIT leases the properties and collects rent. REITs are a popular investment vehicle because they provide a steady source of income without requiring investors to actually manage any of the properties themselves. REITs often focus on a particular type of real estate. For instance, a cannabis REIT might consist of multiple dispensaries that generate income through monthly rent paid by the cannabis operators. Many REITs are regulated by the U.S. Securities and Exchange Commission (SEC) and are publicly traded like stocks, allowing investors to buy and sell as shareholders.
ROI, or Return on Investment, is a straightforward measure of how much profit an investment generates relative to the cost of the investment. An ROI calculation is typically expressed as either a percentage or a ratio, with the net profit of an investment divided by the capital invested. Prospective investors can use ROI to compare different investment opportunities and measure the potential performance of each one. ROI is often used as a performance measure for commercial real estate investments because the ROI formula easily incorporates variables such as monthly rent generated and maintenance costs. Real estate ROI calculations can be complicated, however, when there is an increase in property taxes or a change in financing terms.
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