Pricing & Risk: 45 Key Terms

By Devon Coombs, CPA, MBA · Teaching Professor of Finance, Santa Clara University · Reviewed August 2026

Pricing a property means converting expected cash flows into a defensible value, typically through direct capitalization or discounted cash flow analysis, while risk analysis examines the uncertainty around that value. The vocabulary in this area covers mortgage mechanics such as the adjustable-rate mortgage, the adjustment interval, and the annual percentage rate, along with rate-building tools such as the band of investment and the built-up method, and risk categories such as business risk and default risk. Week 5 of the free Real Estate Finance course applies these terms to the question of what constitutes a fair price to pay. Small differences in rates and assumptions often produce large differences in value, which makes precise definitions worth the effort.

These terms are taught in Week 5: What Is a Fair Price to Pay? Direct Cap, DCF, Mortgages & Risk of the free Real Estate Finance course; the full course glossary collects every chapter in one place.

adjustable-rate mortgage: An ARM: a loan whose rate resets on a schedule from a published index (e.g., SOFR or a Treasury yield) plus the lender’s fixed margin, subject to periodic and lifetime caps. It reallocates interest rate risk from lender to borrower, usually in exchange for a lower starting rate.
adjustment interval: How often an ARM reprices once changes begin; one year is most common, including on hybrid ARMs fixed for the first 3, 5, or 7 years.
annual percentage rate: APR: the EBC-style disclosure rate the Truth-in-Lending Act requires on consumer home loans. Calculated under regulatory rules, it may omit some economically relevant costs and can understate the realized cost for borrowers who repay early.
APR: Annual percentage rate: the regulated disclosure rate on consumer loans that folds specified finance charges into an annualized cost of credit. Similar in concept to effective borrowing cost.
ARM: Adjustable-rate mortgage: resets from index + margin on a set interval, with caps and floors limiting movement. The index is an interest-rate benchmark, not an inflation index.
band of investment: A cap rate built by weighting each capital source’s current income requirement by its share of the stack: Cap Rate = LTV × Mortgage Constant + Equity Share × Equity Dividend Rate. Useful when comparable sales are limited.
built-up method: A required unlevered return assembled from a benchmark risk-free rate (often the 10-year Treasury) plus premiums for real estate risk, illiquidity, management burden, and property-specific factors. Conceptually useful but subjective, so cross-check against market evidence.
bullet loan: An interest-only loan with the full principal balance due at the balloon, one large final payment. Used for short holds or to maximize interim cash flow.
business risk: Variation in NOI from economic and market conditions: recessions, tenant demand, new competing supply. Managed by market selection, tenant diversification, staggered lease expirations, and scenario underwriting.
default risk: The lender’s risk that the borrower stops paying. Managed through DSCR/LTV/debt-yield underwriting, collateral quality, reserves, and recourse or carve-out guarantees.
diversification: Risk reduction from combining assets that do not move together: across property types, geographies, tenants/industries, and strategies or debt maturities. It manages the risks underwriting cannot, but requires scale in direct real estate.
EBC: Effective borrowing cost: the borrower’s all-in IRR including points and third-party up-front costs. On the worked loan it is 6.36% held to maturity, 6.61% if prepaid at Year 5.
effective borrowing cost: EBC, the IRR on the borrower’s cash flows: net proceeds after points AND third-party closing costs, versus the full payment schedule. Sits at or above lender’s yield, and rises further if the loan is repaid early (upfront costs spread over fewer years).
environmental risk: Loss from contamination or hazards, where remediation can exceed the property’s value. Managed with Phase I/II assessments, environmental insurance, and seller indemnities.
financial risk: The added volatility debt imposes on equity returns: magnified gains and losses. Indicated by DCR and LTV; managed with moderate leverage and fixed-rate debt. The equity dividend rate is a return measure, not a measure of financial risk.
fully amortized loan: A loan whose term equals its amortization period, so the balance reaches zero with the final scheduled payment. Common in residential mortgages.
fully indexed rate: The ARM’s index plus the lender’s margin: a 4.10% index plus a 2.40% margin produces a 6.50% fully indexed rate.
Gordon Growth Model: Values a growing perpetuity and yields the decomposition R = Y − g: the cap rate equals the required return minus expected long-term income growth. Explains why a low cap rate can price strong growth rather than overpricing.
inflation risk: Erosion of real returns when income is contractually locked and prices rise unexpectedly. Managed with shorter leases, CPI escalations, and expense pass-throughs.
interest rate risk: Value and debt-cost changes caused by interest rate movements: rates reprice values through cap rates and reprice floating or maturing debt. Managed with fixed-rate debt, interest-rate caps, and laddered maturities.
interest-only loan: Payments cover interest alone, so the principal balance does not decline during the interest-only period. If no amortization occurs before maturity, the original principal is due as a balloon.
interest-rate cap: A contractual or purchased limit on how high a floating rate can go: periodic caps limit each reset, lifetime caps limit total movement, and commercial floating-rate borrowers often buy caps to protect project cash flow.
land acquisition loan: A short-term, low-leverage, often recourse loan for buying raw or entitled land, where there is no income to underwrite yet.
land development loan: Staged financing for grading, utilities, streets, and other site infrastructure, funded as work completes.
legislative risk: Rule changes mid-hold: tax law, rent control, zoning, and regulation. Managed through jurisdiction due diligence and diversification across jurisdictions.
lender's yield: The internal rate of return on the lender’s cash flows: the net amount disbursed after origination fees, versus the payments and balloon received. Points lift it above the note rate (6.29% vs 6.00% on the worked loan).
loan syndication: Several lenders share funding of one large loan; one lender leads the transaction, coordinates underwriting, and may act as administrative agent or servicer.
lockout: A contract period during which voluntary prepayment is prohibited entirely.
management risk: Outcome dependence on operator skill: leasing, maintenance, expense control. Managed with capable property management, aligned incentives, and budget oversight.
market extraction: Deriving cap rates from comparable transactions: divide each comp’s NOI by its sale price and use the resulting cap rates as evidence for the subject. The most common method, but it needs recent, arm’s-length, truly comparable sales.
mezzanine loan: Junior debt secured by a pledge of the equity interests in the property-owning entity (LLC or LP) rather than a lien on the property. It is foreclosable under the UCC, often faster than mortgage foreclosure, and permitted where senior documents prohibit junior property liens.
mini-perm: A 3-to-5-year loan carrying a completed project through the period between construction completion and full stabilization, until it qualifies for permanent debt.
Monte Carlo simulation: Scenario analysis at scale: assign probability distributions to key inputs (rent growth, vacancy, exit cap, rates), run the DCF thousands of times, and read off a distribution of outcomes, such as the probability IRR falls below the hurdle. Only as good as its input distributions.
nonrecourse loan: A loan whose claim is limited to the property and borrower entity: the lender cannot generally pursue the sponsor’s personal assets, except under bad-boy carve-outs for fraud, misapplication of funds, and other specified acts.
note rate: The contract interest rate that determines how interest accrues on the loan balance. It understates the loan’s full economics once origination points and closing costs are included; that is what lender’s yield and EBC measure.
partially amortized loan: A loan whose term is shorter than its amortization schedule, so a balloon payment is due at maturity, as with a 30-year amortization schedule carrying a 10-year term (a $13.39M balloon).
prepayment penalty: A fee charged on early payoff, often a declining percentage of the outstanding balance (e.g., 5-4-3-2-1). One of the standard commercial prepayment protections alongside lockout, yield maintenance, and defeasance.
prepayment risk: The lender’s risk that the borrower repays or refinances when rates fall, just when the fixed-rate stream is most valuable. Managed with lockouts, prepayment penalties, yield maintenance, and defeasance.
reinvestment risk: The lender’s risk that principal returned through amortization or prepayment must be re-lent at whatever rates prevail, often lower, just when the old fixed rate was most valuable.
second mortgage: A junior lien on the same real estate, standing behind the first mortgage. Contrast with a mezzanine loan, which holds no property lien at all.
special-purpose entity: An SPE: a single-asset LLC or limited partnership formed to own one property, isolating it from other business risks and enabling nonrecourse loan structures.
teaser rate: An introductory ARM rate set below the fully indexed rate. At the first adjustment the loan may reset toward index + margin, subject to caps, even if the index has not moved.
Truth in Lending Act: The 1968 federal law requiring lenders to compute and disclose the APR on home loans.
unlevered discount rate: The required total return used to discount property-level cash flow before debt service, often built as risk-free rate + real estate risk premium + property-specific adjustment. It should not be used on levered equity cash flows.
WACC: Weighted average cost of capital, corporate finance’s blended discount rate: D/V × Cost of Debt × (1 − Tax Rate) + E/V × Cost of Equity, applied to after-tax enterprise cash flows. The real estate analogue is the pre-tax unlevered property discount rate.

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