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what is a real estate limited partnership relp | a real estate limited partnership relp is a group of investors who pool their money to invest in property purchasing development or leasing it is one of several forms of real estate investment group reig under its limited partnership lp status a relp has a general partner who assumes full liability and one or more limited partners who are liable only up to the amount they contribute the general partner is usually a corporation an experienced property manager or a real estate development firm the limited partners are outside investors who provide financing in exchange for an investment return under u s tax code partnerships are not taxed rather partnerships do a so called pass through sending all of their income to the partners and reporting on form k 1 partners receiving a k 1 must individually file their partnership income on form 1040 if they are an individual or on form 1120 if they are a corporation understanding real estate limited partnerships relps a relp provides individuals with the opportunity to invest in a diversified portfolio of real estate investments relps are but one of several options available to those looking for real estate investment exposure they also include real estate investment trusts reits managed real estate focused investment funds and other real estate portfolio options a relp may provide returns that beat other options while simultaneously carrying comparably higher risk depending on the structure of the lp partners may or may not be involved in the management of the business partnership agreements detail the full provisions of the business including minimum investments fees distributions partner voting and more some partnerships employ a collaborative forum type of structure for investment decisions while others leave the core management of the business to a few executives generally the management team sources and identifies deals before investing any of the group s capital relps are marketed with detailed partnership agreements that define the terms of the entity and the investment opportunity overall they generally target high net worth individuals and institutional investors some require accredited investor status for limited partnership status special considerationsmany relps have a narrowly defined focus they may provide the business structure for construction of a residential neighborhood a shopping center or a business plaza they often specialize in a real estate niche like retirement developments or high value commercial properties some real estate investment partnerships accept investments of 5 000 to 50 000 that s not enough to purchase a unit but the partnership will pool money from several investors to fund a property that is shared and co ownedrelps may have high returns and high risks making due diligence important for prospective investors the terms of the agreement may require the limited partner to commit to a lump sum contribution a contribution schedule over time or to contributions as called upon notably funds invested in a limited partnership are usually illiquid the investor can t cash out at any time there may be flexibility for various business activities within the portfolio a relp might directly invest in real estate properties issue credit for real estate borrowers or participate in a collaborative business deal partners roles in a relpthe general partner usually has a vested interest in the partnership overall and provides a portion of the capital general partners have a direct role in the management of the business with designees often serving on the board of directors and involved in the day to day management of the business overall general partners hold active decision making authority lps have limited liability and it usually comes with limited influence and involvement in the entity s governance some entities set up advisory boards or other means of communication to encourage the insights and participation of limited partners generally limited partners are hands off investors limited partners receive dividend distributions along with pass through income annually which constitutes part of their return many limited partnerships have a fixed term lifespan so that partners receive their principal at a specified maturity date taxes and relpsas with any partnership a relp is not required to pay taxes the net income or losses are passed through to the partners annually this requires the partnership to file a form 1065 informational return with the internal revenue service and to report all distributions of income through individual partner k 1s all of the partners in the business receive distributions throughout the year and a distribution of income annually the relp is responsible for providing each partner with a k 1 which details the income they have received for the year partners are then required to report their income individually as appropriate relps do not pay taxes directly net income or losses are passed along to investors who are responsible for tax reporting | |
what is a real estate mortgage investment conduit remic | the term real estate mortgage investment conduit remic refers to a special purpose vehicle spv or debt instrument that pools mortgage loans together and issues mortgage backed securities mbss understanding real estate mortgage investment conduits remics remics are complex investments that generate income for issuers and investors mortgage pools are generally broken up into tranches repackaged and marketed to investors as individual securities 1 remics can take on several different forms and are generally deemed pass through entities as such they are exempt from being taxed directly real estate mortgage investment conduits remics were first authorized by the enactment of the tax reform act of 1986 they hold commercial and residential mortgages in trust and issue interests in these securitized mortgages to investors they are considered to be a safe option for investors who are averse to risk 2remics piece together individual mortgages into pools based on risk and maturity just like collateralized mortgage obligations cmos they are divided into bonds or other securities that are then sold to investors 1 these securities are traded on the secondary mortgage market some of the industry s most prominent issuers of real estate mortgage investment conduits include fannie mae and freddie mac 3 these companies are backed by the federal government although they don t actually issue mortgages they do guarantee home loans issued by other lenders in the secondary market other remic issuers include mortgage lenders and insurance companies as well as savings institutions 3fannie mae and freddie mac are some of the more prominent issuers of remics remics may be organized as partnerships trusts corporations or associations and are federally tax exempt entities investors who own these securities though are still subject to individual income taxation 4 tax laws prevented remics from making modifications to their mortgage loans as such the entity could lose its tax exempt status if a loan within its pool is exchanged for another loan that s because federal regulations require loans in a given pool to be constant in other words the loans cannot be significantly modified or exchanged for different loans with new terms 5changes to remicsseveral changes were either proposed or made to protect the structure and tax exempt status of remics congress introduced the real estate mortgage investment conduit improvement act in 2009 to ease restrictions on commercial real estate loans securitized by remics owners of troubled properties with commercial loans weren t able to make changes to their assets because their plans would change the value of the collateral that secured the loan 6the proposed law would allow property owners with commercial loans securitized by remics to make improvements and enhancements that would make their properties more attractive to the market the legislation included a declaration that property modifications under such terms would not be regarded as prohibited transactions as outlined by the internal revenue service irs 6the interest in the remic would continue to be treated as regular interest and proceeds that were generated by modifications to the property would be handled the same as if received through qualified mortgages 6the act was referred to the committee on banking housing and urban affairs but hasn t moved any further 6the federal government provided some relief for people with commercial and residential loans suffering from hardships due to the covid 19 pandemic homeowners unable to make payments were granted forbearance first under the coronavirus aid relief and economic security cares act which was signed by former president donald trump in 2020 and then again when the biden administration extended the provisions 78because the relief would ultimately change the structure of these loans it would have an effect on how remics are structured too the irs has ensured that these investments and their issuers will remain safe from any tax implications if borrowers take advantage of these emergency measures 5real estate mortgage investment conduit remic vs collateralized mortgage obligation cmo the industry commonly considers remics to be cmos which are a series of mortgages that are bundled together and sold to investors as investments but there are some distinctions between the two cmos exist within remics although cmos are separate legal entities for tax and legal purposes a remic on the other hand is exempt from federal tax but that s only on the income investors collect from the underlying mortgages at the corporate level any income generated and paid out to investors is taxable using form 1066 when filing a remic 9real estate mortgage investment conduit remic vs real estate investment trust reit both remics and real estate investment trusts reits invest in real estate in some form or another but while remics pool mortgage loans and sell them off as investments to investors reits are a whole different ball game reits are companies that own and operate a portfolio of income generating properties such as office and retail space condominiums and mixed use properties investors can purchase shares in reits that are traded on exchanges just like stocks companies lease or rent out their properties and that income is then paid out to investors as dividends 10just like remics though reits aren t taxed but investors must report any earnings from these investments on their annual tax returns which means they are taxed at their own tax rate 11 | |
what is a real estate operating company reoc | a real estate operating company reoc is a publicly traded company that actively invests in properties generally commercial real estate unlike real estate investment trusts reits reocs reinvest the money they earn back into their business and are subject to higher corporate taxes than reits understanding real estate operating companies reocs investors have a number of options if they wish to diversify their holdings and add real estate to their portfolios purchasing real property is one option but that can come at a big cost and immense risk investors who buy properties residential and or commercial real estate must be able to bear the financial burden of purchasing and maintaining properties in addition to the risks and uncertainties that come with the housing market reocs can shield investors from some of the risks that come with holding real property owning a few shares in one of these companies gives you immediate exposure to several different types of real estate that are carefully selected and then managed by a team of experts the majority of their holdings are commercial properties such as retail stores hotels office buildings shopping malls and multifamily homes many reocs also invest in and manage properties for instance a company may sell or lease out units of a multifamily home or office building to different people but still maintain and earn money from common spaces such as parking lots and lobbies shares in reocs are traded on exchanges just like any other publicly traded company investors can purchase shares through their broker dealer or another financial professional although they eliminate the risk of holding physical property reocs are subject to certain market risks including interest rate risk housing market risks liquidity risk and credit risk reocs pay federal taxes because they are not required to distribute their earnings to shareholders reocs vs reitsalthough they both invest in real estate holdings there are functional and strategic differences between reocs and reits reits own and operate properties that generate income through rents or leases these may be residential dwellings hotels and even infrastructure properties such as pipelines and cell phone towers investors can choose to buy shares in three different types of reits equity reits mortgage reits and hybrid reits reocs are structured in a way that allows them to reinvest their earnings back into the company rather than distribute them to shareholders as such they can expand their holdings by purchasing new properties or put money back into existing holdings to improve them they may also use earnings to buy new properties for the express purpose to sell them back at a later date being able to reinvest their earnings means reocs get no favorable tax treatment so they pay higher taxes than reits in order to qualify as a reit companies must meet certain requirements these include among others investing a minimum of 75 of their assets in real estate and distributing at least 90 of their earnings to unitholders in exchange reits get favorable tax treatment corporate taxes for reits are far lower than those imposed on reocs because they are exempt from federal taxation 1reits tend to invest and purchase properties that limit the amount of risk associated with certain commercial properties because of the special tax status they enjoy their investment strategies tend to be for the long term this means reits don t purchase investment properties in order to sell them in the future the same way some reocs do | |
what is real estate owned reo | the term real estate owned reo refers to a lender owned property that is not sold at a foreclosure auction properties become reo when owners default and the bank repossesses them and tries to sell them the lender which is often a bank takes ownership of a foreclosed property when it fails to sell at the amount sought to cover the loan these properties generally come at a steep discount but may require extensive repairs investopedia zoe hansenunderstanding real estate owned reo properties | |
when a borrower defaults on their mortgage the pre foreclosure period often involves either a real estate short sale or a public auction if neither goes through the foreclosure process can end with the lender taking ownership of the property lenders may be banks non traditional lenders quasi government entities like fannie mae and freddie mac or other government entities | lenders may attempt to sell reo properties in their portfolios without the help of real estate agents when this is the case banks or government agencies often list their reo properties on their websites a bank s loan officers may also notify customers looking for homes about the reo properties in its portfolio the department of housing and urban development lists single family reo homes for sale on the hud home store 1reo properties are managed by the lender s reo specialist their role includes the reo specialist also works closely with the lender s in house or contracted property manager to ensure properties are secure and winterized or to prepare a property for vacancy the reo specialist undertakes these job functions to help the bank liquidate its properties quickly and efficiently special considerationsreo specialists often contract the services of local real estate agents to list the properties in the multiple listing service mls so they get more exposure listing properties in the mls ensures that potential buyers who real estate websites as well as sites like zillow realtor com redfin and trulia will see the listings reo listing agents bring any offers they receive to the reo specialist real estate agents negotiate the commission they receive for selling reo properties with the reo specialist the commission that buyers pay to their agents will depend on a 2024 settlement in a lawsuit against the national association of realtors nar which proposed eliminating the standard 6 commission rate that was split between buyers and sellers agents if the new rules from the settlement are formally adopted both buyers and sellers will have the option to negotiate commissions separately with their agents brokers how compensation offers are made would also change 2 | |
how a property gains reo status | so how does a property become real estate owned there is a process that lenders must adhere to for it to go from the original owner to lender owned it starts with the borrower defaulting on their mortgage or home loan lenders normally have a cut off date generally within a few months when a mortgage is in default lenders try to work with the borrower to bring it up to date if not it goes to the next stage foreclosure foreclosure is a legal process it allows lenders to repossess the property and try to sell it to recoup the outstanding balance of the loan there are instances when lenders can t sell the property this is the point at which it becomes real estate owned the lender manages the property and prepares it for listing on the market to help ensure a smooth closing buyers should also search public records to ensure that all liens associated with a property have been paid advantages and disadvantages of a reo propertyreo properties can be attractive to real estate investors and homebuyers because they re cost effective investments banks may often sell them at a discount to their market value since selling such properties is not typically their primary business line many properties that come through the foreclosure process don t have only outstanding loans there also may be other defaulted payments on them this can include property tax payments and other debts the point of foreclosure is to remove any liens from the property and sell it purchasing an reo means they come lien free so there are no defective titles and no outstanding debts the majority of lenders don t want to hold onto reo properties keeping them on the market means they lose money as such they re usually more motivated to unload the reo property than a regular seller would their own home instead of doing the back and forth lenders may be more willing to negotiate which means buyers can often walk away paying a lower price than they otherwise would lenders typically sell reo properties on an as is basis this means they will not make any major repairs or renovations prior to selling these properties are often in disrepair so it s crucial to have a thorough home inspection and be prepared to make and pay for renovations that may be needed a highly neglected or damaged property may require extensive repairs and upgrades to make it habitable again the cost of repairs can often negate any savings buyers have on the actual purchase price although single family home occupants may be evicted prior to listing multi family homes may still be occupied by tenants this means buyers may end up becoming landlords even if they never intended to take on that role buyers will have to take precautions to ensure they are compliant with local and state landlord tenant laws by honoring existing leases discounted pricesno outstanding liens or debtslenders may be willing to negotiateproperties are sold as ishigh cost of repairsproperties may be tenanted | |
what does real estate owned mean | a real estate owned property is managed by a bank or other lender properties that fall under this category are taken over by lenders after the original borrowers default on their mortgages lenders go through the foreclosure process to repossess the property and sell it at auction if the property isn t sold it becomes part of the lender s inventory | |
how does a property become real estate owned | there is a process that a property must go through before they can become real estate owned first the borrower goes into default if the lender cannot negotiate repayment of the mortgage they can repossess the property this allows them to evict any occupants provided it s a single family home and prepare the property for sale at auction if the property can t be sold it becomes part of the lender s inventory and therefore real estate owned | |
how much buyers should offer on a real estate owned property varies lenders are often highly motivated to sell reo properties which means they often come at a bigger discount compared to properties being sold by an owner if you still feel that you re not getting the best price look at the market value of the property and other comparable homes in the area and make your offer | the bottom linereal estate can present a lucrative investment opportunity to save money on the purchase price many investors find opportunities in real estate owned properties which are owned by lenders these properties go through the default and foreclosure process and aren t sold at auction because it can be costly to maintain reo properties lenders are often highly motivated to sell you can get these properties at a steep discount but if they are neglected or require extensive repairs the cost of renovations can cancel out any savings from the lower selling price | |
what is the real estate settlement procedures act respa | the real estate settlement procedures act respa was enacted by the u s congress in 1975 to provide homebuyers and sellers with complete settlement cost disclosures respa was also introduced to eliminate abusive practices in the real estate settlement process prohibit kickbacks and limit the use of escrow accounts respa is a federal statute now regulated by the consumer financial protection bureau cfpb understanding the real estate settlement procedures act respa initially passed by congress in 1974 respa became effective on june 20 1975 respa has been impacted over the years by several changes and amendments enforcement initially fell under the jurisdiction of the u s department of housing and urban development hud after 2011 those responsibilities were assumed by the cfpb because of the dodd frank wall street reform and consumer protection act 2from its inception respa has regulated mortgage loans attached to one to four family residential properties the objective of respa is to educate borrowers regarding their settlement costs and eliminate kickback practices and referral fees that can inflate the cost of obtaining a mortgage the types of loans covered by respa include the majority of purchase loans assumptions refinances property improvement loans and home equity lines of credit helocs 1respa does not apply to extensions of credit to the government government agencies or instrumentalities or in situations where the borrower plans to use property or land primarily for business commercial or agricultural purposes respa requirementsrespa requires lenders mortgage brokers or servicers of home loans to disclose to borrowers any information about the real estate transaction the information disclosure should include settlement services relevant consumer protection laws and any other information connected to the cost of the real estate settlement process business relationships between closing service providers and other parties connected to the settlement process also should be disclosed to the borrower 3 | |
what does respa prohibit | respa prohibits specific practices such as kickbacks referrals and unearned fees for example section 8 prohibits any person from giving or receiving something of value in exchange for referrals of a settlement service business it also regulates the use of escrow accounts such as prohibiting loan servicers to demand excessively large escrow accounts and restricts sellers from mandating title insurance companies 4respa does allow an exception in which brokers and agents can exchange reasonable payments in return for goods or services provided by other settlement service providers as long as those arrangements are compliant with the law and regulatory guidelines 5respa does not prohibit joint market efforts between a real estate broker and a lender as long as advertising costs paid by each party are related to the value of any goods or services that might be received in return but transactions in which one party pays more than a pro rata share of advertising costs are prohibited sponsorship of events also may be considered prohibited actions if one party uses the event to market or advertise its services 6real estate brokers and title agents are barred from entering into market service agreements when one party charges the other an amount for marketing materials that exceeds the fair market value of marketing services performed a settlement service provider may not rent space from another settlement service provider unless it s paying fair market value to do so 7real estate brokers cannot pay agents to refer clients to the broker s affiliate mortgage company brokers cannot offer referral fees to other brokers for directing clients to their business these cooperative fees are prohibited and are essentially viewed as a form of kickback mortgage lenders cannot offer any type of referral incentive to local real estate agents for referring homebuyers to their loan products 4real estate brokers cannot refer business to an affiliated title company without disclosing that relationship to their customers this disclosure must detail the charges that the title company requires for its services and the broker s financial interest in the title company customers also must be made aware that they re not required to use the title company to which they ve been referred real estate brokers and title insurance companies cannot create an affiliated company to collect dividends from referrals 4lenders cannot require borrowers to use a particular affiliate settlement service provider however they can provide financial incentives to do so for example a homebuyer may be able to take advantage of affiliated services at a discounted rate 6in march 2024 the national association of realtors settled a class action lawsuit by homeowners who alleged that the nar had inflated the commissions paid to its realtors if the deal is finalized by the court it is likely to lead to substantially smaller commissions in the future 8enforcement procedures for respa violationsa plaintiff has up to one year to bring a lawsuit to enforce violations where kickbacks or other improper behavior occurred during the settlement process if the borrower has a grievance against their loan servicer there are specific steps they must follow before any suit can be filed the borrower must contact their loan servicer in writing detailing the nature of their issue the servicer is required to respond to the borrower s complaint in writing within 20 business days of receipt of the complaint the servicer has 60 business days to correct the issue or give its reasons for the validity of the account s current status borrowers should continue to make the required payments until the issue is resolved 9a plaintiff has up to three years to bring a suit for specific improprieties against their loan servicer any of these suits can be brought in any federal district court if the court is in the district where either the property is located or the alleged respa violation occurred 10if you don t use a lawyer throughout your real estate transaction it s best to get in touch with one immediately if you believe a respa violation has occurred a real estate lawyer will be able to help you navigate the legal process criticisms of respacritics of respa say that some of the abusive practices that the law is designed to eliminate still occur including kickbacks one example of this is lenders that provide captive insurance to the title insurance companies that they work with a captive insurance company is a wholly owned subsidiary of a larger firm that is tasked with writing insurance policies for the parent and does not insure any other company critics say this is essentially a kickback mechanism because customers usually elect to use the service providers already associated with their lender or real estate agent although customers are required to sign documents that say they are free to choose any service provider because of these criticisms there have been many attempts to make changes to respa one proposal involves removing the option for customers to choose to use any service provider for each service in place of this would be a system where services are bundled but the real estate agent or lender is responsible for directly paying for all other costs the advantage of this system is that lenders who always have more buying power would be forced to seek out the lowest prices for all real estate settlement services who does the real estate settlement procedures act respa protect the real estate settlement procedures act respa is intended to protect consumers who are seeking to become eligible for a mortgage loan however respa does not protect all types of loans loans secured by real estate for a business or agricultural purpose are not covered by respa 11 | |
what information does respa require to be disclosed | respa requires that borrowers receive various disclosures at different times first the lender or mortgage broker must give you an estimate of the total settlement service charges that you likely will have to pay this estimate is a good faith estimate however actual costs may vary the lender or mortgage broker also must provide a written disclosure when you apply for a loan or within the next three business days if they expect that someone else will be collecting your mortgage payments also referred to as servicing a loan 11 | |
why was respa passed | respa was passed as part of an effort to limit the use of escrow accounts and to prohibit abusive practices in the real estate industry such as kickbacks and referral fees the bottom line | |
what is a short sale | a short sale in real estate is an offer of a property at an asking price that is less than the amount due on the current owner s mortgage a short sale is usually a sign of a financially distressed homeowner who needs to sell the property before the lender seizes it in foreclosure all of the proceeds of a short sale go to the lender the lender then has two options to forgive the remaining balance or to pursue a deficiency judgment that requires the former homeowner to pay the lender all or part of the difference in some states this difference in price must be forgiven investopedia nono floresunderstanding a short saleshort sales usually occur when a homeowner is in financial distress and has missed one or more mortgage payments foreclosure proceedings may be looming ahead they also are more likely to occur when the housing market is in a down period such as the 2007 2009 financial crisis which caused home prices to plummet and sales to slow in many regions for example if real estate values drop a homeowner may end up selling a house for 150 000 when there is still 175 000 remaining to be paid on the mortgage the difference of 25 000 less any closing and other selling costs is called the deficiency balance before the process can begin the mortgage lender must sign off on a decision to execute a short sale sometimes termed a pre foreclosure sale the lender typically a bank requires that the mortgage holder submit documentation explaining why a short sale makes sense no short sale can occur without the lender s prior approval short sales tend to be lengthy and paperwork intensive transactions taking up to a full year to process they are not as detrimental to a homeowner s credit rating as a foreclosure 1discrimination in mortgage lending is illegal if you think you ve been discriminated against based on race religion sex marital status use of public assistance national origin disability or age there are steps you can take one is to file a report to the consumer financial protection bureau cfpb or with the u s department of housing and urban development hud special considerationsa short sale hurts a person s credit score less than a foreclosure but it is still a negative credit mark 2 any type of property sale that is denoted by a credit company as not paid as agreed is a ding on the score short sales foreclosures and deeds in lieu of foreclosure all hurt an individual s credit rating to some degree short sales don t always negate the remaining mortgage debt there are two parts to a mortgage the first is the lien against the property that is used to secure the loan the lien protects the lender in case a borrower can t repay the loan it gives the lending institution the right to sell the property for repayment this part of the mortgage is waived in a short sale the second part of the mortgage is the promise to repay lenders can still enforce this portion either through a new note or the collection of the deficiency in any case the lender must approve the short sale which means borrowers are sometimes at their whim | |
when convincing a lender to agree to a short sale the homeowner must be able to cite a new source of financial difficulty not something that was withheld at the time the mortgage was approved | short sale vs foreclosurea short sale or foreclosure are two possible outcomes for homeowners who are behind on their mortgage payments own a home that is underwater or both in either case the owner is forced to part with the home but the timeline and consequences are different in a foreclosure the lender seizes the home after the borrower fails to make payments unlike a short sale a foreclosure is initiated by the lender alone foreclosure is the last option for the lender in such cases the lender repossesses the home hoping to eventually make good on its investment in the mortgage unlike in most short sales many foreclosures take place after the homeowner abandons the home if the occupants are still in the home they are evicted by the lender once the lender has access to the home it orders an appraisal and puts it up for sale foreclosures normally take less time to complete because the lender wants to liquidate the asset quickly foreclosed homes may even be auctioned off at a public trustee sale depending on the circumstances homeowners who experience foreclosure have to wait for two to seven years to purchase another home a foreclosure is kept on a person s credit report for seven years a distressed homeowner generally gets to stay in the home during the short sale process a homeowner who has gone through a short sale may with certain restrictions be eligible to purchase another home immediately while a foreclosure essentially lets you walk away from your home albeit with grave consequences for your financial future such as having to declare bankruptcy and destroying your credit completing a short sale is labor intensive however the payoff for the extra work involved in a short sale may be worth it less drastic alternatives to a short sale include loan modification or the use of private mortgage insurance short sale alternativesbefore resigning yourself to a short sale talk to your lender about the possibility of a revised payment plan or loan modification one of these options might allow you to stay in your home and get back on your feet obtaining a loan modification may temporarily lower your credit score as will any application for new credit another possible option for staying in your home may be available if you have private mortgage insurance pmi many homeowners who purchased homes with less than 20 down were required to purchase pmi with their homes if the pmi company thinks you have a chance to recover from your current financial situation it may advance funds to your lender to bring your payments up to date eventually you ll have to repay the advance the short sale processseveral steps are necessary to pull off a short sale before beginning the process struggling homeowners should consider how likely it is that the lender will agree to work with them on a short sale the lender is not required to cooperate the source of the financial trouble should be new such as a health problem the loss of a job or a divorce rather than something that was not disclosed when the homebuyer originally applied for the loan the lender won t be sympathetic to a dishonest borrower however if you feel you were a victim of predatory lending practices you may be able to talk the lender into a short sale even if you have not had any major financial catastrophes since purchasing the home to put yourself in a more convincing position stop purchasing non necessities you don t want to look irresponsible to the lender when it reviews your proposal be aware of other circumstances that may prevent the approval of a short sale if you are not in default on your mortgage payments yet the lender probably won t be willing to work with you if the lender thinks it can get more money from foreclosing on your home than from allowing a short sale it may not allow one if someone cosigned the mortgage the lender may hold that person responsible for payment rather than doing a short sale 1if you think your situation is ripe for a short sale talk to a decision maker at the bank about the possibility don t just speak to a customer service representative immediately ask to speak with the lender s loss mitigation department if you don t like what the first decision maker says try talking to another one on another day and see if you get a different answer if the lender is willing to consider a short sale you re ready to move forward with creating the short sale proposal and finding a buyer you may want to consult with an attorney a tax professional and a real estate agent while these are high priced professional services if you try to handle a complex short sale transaction yourself you may find yourself in even bigger financial trouble you may be able to pay for these service fees out of the sale proceeds from your home professionals accustomed to dealing with short sale transactions will be able to give you guidance on how to pay them new rules for the national association of realtors expected to take effect in july2024 may lower commissions for home buyers and sellers if a federal courtapproves the changes the standard 6 commission ends and sellers no longerhave to propose compensation to prospective buyers and their agents nar willalso require brokers to enter into written agreements with their buyers to helpconsumers understand what services will be provided and at what cost 3 | |
when setting an asking price make sure to factor the cost of selling the property into the total amount of money you need to get out of the sale of course you want to sell the home for as close to the value of your mortgage as possible but in a down market there is bound to be a shortfall | in some states even after a short sale the bank will expect you to pay back all or part of that shortfall gather all the documents you ll need to prove your financial hardship to the lender these may include bank statements medical bills pay stubs a termination notice from your former job or a divorce decree it is up to you to come up with a proposal be aware that the lender ultimately must approve a short sale after receiving all the details because the lender is the recipient of the proceeds your job is to find a buyer for your home 4once you have a buyer and the necessary paperwork you are ready to submit the buyer s offer and your proposal to the bank along with the documentation of your distressed financial status your proposal should include a hardship letter explaining the circumstances that are preventing you from making your mortgage payments you want to make it as convincing as possible and protect your interests while also appealing to the bank be careful about submitting your financial information to a lender if it does not approve the short sale it may use your financial information to try to get money out of you in foreclosure proceedings if you still have cash assets you may be expected to use them to continue making mortgage payments or to make up the shortfall between the sale price and the mortgage amount an attorney experienced in completing short sales can help you navigate the details short sales can take longer than regular home sales due to the need for lender approval they often fall through too the buyer may find another property while you re waiting on an answer from the lender be prepared for this possibility if the short sale transaction goes through consult with the internal revenue service irs to see if you will have to pay taxes on the shortfall | |
don t forget that a short sale can still affect your credit score the months of mortgage payments that you missed before the short sale can show up as delinquent payments on your credit report it is up to the bank to decide what to report so it s in your best interest to try to convince the bank not to report your defaulted payments | your bank may be more likely to be generous in this regard if you brought up your hardship before you were significantly behind short sale strategies for buyers and investorsshort sales can provide excellent opportunities for buyers to get houses at a reduced price here are a couple of tips to help you make smart decisions when considering a short sale property most short sale properties are listed by real estate agents and on real estate websites some listings may not be advertised as short sales so you might have to look for clues within the listing it may be indicated as subject to bank approval 5an experienced real estate agent can make a big difference in terms of finding and closing short sale properties agents who specialize in short sales may hold a short sales and foreclosure resource sfr certification a designation offered by the national association of realtors nar 6holders of this certification have specialized training in short sales and foreclosures qualifying sellers for short sales negotiating with lenders and protecting buyers short sales are complicated time consuming transactions for both the buyer and the seller it can take weeks or months for a lender to approve a short sale and many buyers who submit an offer end up canceling because the process takes too long rules for short sale transactions vary from state to state but the steps normally include if you are buying a house in a short sale with the intention of flipping it the key to a profitable transaction is a good purchase price advantages and disadvantages of a short saleshort sales allow a homeowner to dispose of a property that is losing value although they do not recoup the costs of their mortgage a short sale allows a buyer to escape foreclosure which can be much more damaging to their credit score in some cases the lender may write the remaining debt as a loss thereby reducing the owner s debt burden a short sale also allows the homeowner to reduce the amount of fees they pay when they sell the home in most cases these fees are the obligation of a property owner when they sell the property in a short sale these fees are paid by the lender for buyers the benefits of a short sale are evident they get a discount price on a home from a lender that s motivated to sell the property on the other hand the buyer has to do a lot more homework short sales typically don t come with the same disclosures as a regular sale and it is up to the prospective buyer to identify any problems with a property allows homeowners to dispose of a debt that they are unlikely to repay homeowners have to pay fewer fees than a typical home sale short sales allow buyers to buy property at a discountlenders may write off part of the debt as a loss short sales come with fewer legal disclosures than a typical home sale there is more paperwork involved in a short sale short sales can damage the seller s credit rating but less than a foreclosure mistakes to avoidhomes in a short sale are sold as is without the mandatory seller obligations of a normal real estate sale since short sales do not come with the typical disclosures of a normal house sale it falls on the prospective buyer to inspect the property and identify any faults short sold homes may be in worse conditions than the average home on the market making it all the more important to identify any problems it is also possible that a prospective buyer may not give themselves enough time before closing as mentioned short sales tend to require more work than an average house sale meaning that they may also take longer to close buyers should be careful to make sure they have time to complete the process before the sale closes it s all in the numbersin real estate investing it is said that the money is made in the buy this means that a good purchase price is often the key to a successful deal if you can get a property for a good price you increase the odds of coming out ahead when it comes time to sell if the purchase price is on the high end on the other hand you ll watch your profit margin erode you should be able to buy the property put it in great condition and sell it at a profitable price investors need to be able to turn around and sell the house quickly typically at below market and a good purchase price makes this possible the purchase price is only one important number however you ll have to make some other calculations as well including these costs will vary depending on the property s condition and your plans for it it pays to put in the time and effort to develop a realistic budget as this is one of the figures you ll need to determine if the investment can make money costs to consider include material labor permits inspection fees trash removal storage costs and dumpster rentals a good inspection before making the purchase can alert you to any large expenses such as a cracked foundation faulty wiring or extensive termite damage arv is an estimate of the property s fair market value fmv after any repairs and renovations are made investors look at this number to determine whether a property has profit potential the best way to evaluate a property s arv is to look at comparables comps these are homes that have recently sold in the area typically up to a mile away from the subject property that have similar features in terms of square footage such as the number of bedrooms and bathrooms carrying costs are your expenses for holding onto the property the longer you own the property the more you will spend on carrying costs which include for an investment to be profitable the sum of your costs the purchase price repair and renovation costs and carrying costs must be lower than the arv if your costs are close to or higher than the arv it will be difficult or impossible to make a profit you can determine the potential profit by subtracting the purchase price repair and renovation costs and carrying costs from the arv real estate investors might expect to earn at least a 20 profit on a property some use guidelines to evaluate properties in various housing markets under these guidelines the total investment purchase price repair and renovation costs and carrying costs should not exceed if the arv of a property is 200 000 for example your total investment should be limited to about 160 000 in a rising market 140 000 in a flat market and 120 000 in a market with falling values the various investment levels are used to reduce risk in changing market conditions you can risk more in a rising market because you are more likely to get your arv or better when you sell in a falling market you are less likely to get your arv so your investment should be smaller | |
what is a short sale | in real estate a short sale may take place when an owner sells a house at a price that is less than the outstanding mortgage amount this typically happens when the owner is under financial stress and is behind on mortgage payments the owner is obligated to sell the home to a third party with all of the proceeds of the sale going to the lender the lender must approve the short sale before it happens the process can take as long as a year due to the paperwork involved | |
what is the difference between a short sale and a foreclosure | in a short sale the process is initiated by the homeowner to get out of financial trouble the owner must prove the extent of the financial distress through documents submitted to the lender if the lender agrees to move forward the homeowner is responsible for finding a buyer in a foreclosure the lender initiates the process seizing the home and if necessary evicting the owner who has failed to make payments the foreclosure process is generally faster than a short sale as the lender seeks to liquidate the asset as quickly as possible | |
is it a good idea to buy a short sale property | buying a short sale property can be a good deal for a prospective buyer however it is important to be aware of some of the drawbacks involved short sales can take a long time moreover if the bank believes that a foreclosure proceeding is a more lucrative option it may reject the short sale and move forward with foreclosure instead the bottom linea short sale property can provide an excellent opportunity to purchase a house for less money in many cases short sale homes are in reasonable condition and while the purchase price might be higher than a foreclosure the costs of making the home marketable can be much lower and the disadvantages to the seller can be less severe however because of the lengthy process buyers and sellers must be willing to wait an experienced real estate agent can help you determine a fair offer and negotiate with the bank because tax laws are complicated and constantly changing you should consult with a certified public accountant cpa who knows about real estate investing and the related tax laws to give you comprehensive and up to date information it can mean the difference between making a profit and taking a loss on an investment | |
what is real gross domestic product gdp | real gross domestic product gdp is an inflation adjusted measure that reflects the value of all goods and services produced by an economy in a given year real gdp is expressed in base year prices it is often referred to as constant price gdp inflation corrected gdp or constant dollar gdp put simply real gdp measures the total economic output of a country and is adjusted for changes in price investopedia paige mclaughlinunderstanding real gross domestic product gdp real gdp is a macroeconomic statistic that measures the value of the goods and services produced by an economy in a specific period adjusted for price changes essentially it measures a country s total economic output taking price changes into account whether they are due to inflation or deflation 1governments use both nominal and real gdp as metrics for analyzing economic growth and purchasing power over time this is done using the gdp price deflator also called the implicit price deflator which measures the changes in prices for all of the goods and services produced in an economy to determine real gdp economists take nominal gdp and adjust it for price changes 2the bureau of economic analysis bea provides a quarterly report on gdp with headline data statistics representing real gdp levels and real gdp growth nominal gdp is also included in the bea s quarterly report under the name current dollar unlike nominal gdp real gdp accounts for changes in price levels and provides a more accurate figure of economic growth 3the u s real gdp growth rate during the first quarter of 2024 annualized 3calculating real gdp is a complex process typically best provided by the bea in general you calculate real gdp by dividing nominal gdp by the gdp deflator r real gdp nominal gdp r where gdp gross domestic product r gdp deflator begin aligned text real gdp frac text nominal gdp text r textbf where text gdp text gross domestic product text r text gdp deflator end aligned real gdp rnominal gdp where gdp gross domestic productr gdp deflator the bea provides the deflator on a quarterly basis the gdp deflator is a measurement of inflation since a base year dividing the nominal gdp by the deflator removes the effects of inflation 4for example if an economy s prices have increased by 1 since the base year the deflating number is 1 01 if nominal gdp was 1 million then real gdp is calculated as 1 000 000 1 01 or 990 099 | |
what is nominal gdp | as noted above governments rely on both real and nominal gdp to get an idea of where the economy is heading while real gdp takes inflation or deflation into account nominal gdp is a macroeconomic assessment of the value of goods and services using current prices in its measure as such nominal gdp is also referred to as the current dollar gdp 5because nominal gdp measures how well the economy is doing without factoring in price changes due to inflation or deflation it may actually inflate growth because all of the goods and services that are used to determine nominal gdp are valued at prices in the current year the easiest way to calculate nominal gdp is by multiplying real gdp by the gdp deflator nominal gdp real gdp gdp deflator begin aligned text nominal gdp text real gdp times text gdp deflator end aligned nominal gdp real gdp gdp deflator you can also calculate it using the expenditure method nominal gdp c i g x m where c consumer spending i business investment g government spending x m total net exports begin aligned text nominal gdp text c text i text g text x text m textbf where text c text consumer spending text i text business investment text g text government spending text x text m text total net exports end aligned nominal gdp c i g x m where c consumer spendingi business investmentg government spendingx m total net exports although u s real gdp increased by 1 6 in the first quarter of 2024 on an annualized basis nominal gdp which is called current dollar gdp by the bea increased by 4 8 3real gdp vs nominal gdpbecause gdp is one of the most important metrics for evaluating the economic activity stability and growth of goods and services in an economy it is usually reviewed from two angles real and nominal the table below highlights some of the main differences between the two types of gdp used by economists businesses investors and government leaders economists use the bea s real gdp headline data for macroeconomic analysis and central bank planning as the table above indicates the main difference between nominal gdp and real gdp is the taking of inflation into account since nominal gdp is calculated using current prices it does not require any adjustments for inflation this makes comparisons from quarter to quarter and year to year much simpler to calculate and analyze keep in mind though that any comparisons are less relevant as such real gdp provides a better basis for judging long term national economic performance than nominal gdp using a gdp price deflator real gdp reflects gdp on a per quantity basis without real gdp it would be difficult to identify just from examining nominal gdp whether production is actually expanding or if it s just a factor of rising per unit prices in the economy a positive difference in nominal minus real gdp signifies inflation and a negative difference signifies deflation in other words inflation occurs when nominal gdp is higher than real gdp deflation happens when real gdp is higher than nominal gdp the gdp price deflator is considered to be a more appropriate inflation measure for measuring economic growth than the consumer price index cpi because it isn t based on a fixed basket of goods example of real gdp vs nominal gdpreal gdp will be lower than nominal gdp during inflationary periods and is higher when the economy experiences deflation let s demonstrate this using the example of a hypothetical country suppose it had a nominal gdp of 100 billion in 2000 which grew by 50 to 150 billion by 2020 over the same period of time inflation reduced the relative purchasing power of the dollar by 50 looking at just the nominal gdp the economy appears to be performing very well whereas the real gdp expressed in 2000 dollars would actually indicate a reading of 75 billion revealing in fact a net overall decline in economic growth had occurred it is due to this greater accuracy that real gdp is favored by economists as a method of measuring economic performance | |
what does real mean in real gdp | real gdp tracks the total value of goods and services calculating the quantities but using constant prices that are adjusted for inflation this is opposed to nominal gdp which does not account for inflation adjusting for constant prices makes it a measure of real economic output for apples to apples comparison over time and between countries | |
what does real gdp measure | real gdp is an inflation adjusted measurement of a country s economic output over the course of a year the u s gdp is primarily measured based on the expenditure approach and calculated using the following formula gdp c g i nx where c consumption g government spending i investment and nx net exports 6 | |
why is real gdp more accurate than nominal gdp | real gdp is considered to be more accurate than nominal gdp because it factors inflation or price changes into its calculation as such it measures the total health of the economy nominal gdp on the other hand doesn t necessarily provide an accurate picture of the economy or where it s headed that s because it factors current market prices into its calculation this means that it can only be used as a comparative metric to others that aren t adjusted for inflation | |
why is measuring real gdp important | countries with larger gdps will have a greater amount of goods and services generated within them and will generally have a higher standard of living for this reason many citizens and political leaders see gdp growth as an important measure of national success often referring to gdp growth and economic growth interchangeably gdp enables policymakers and central banks to judge whether the economy is contracting or expanding whether it needs a boost or restraint and if a threat such as a recession or inflation looms on the horizon by accounting for inflation real gdp is a better gauge of the change in production levels from one period to another | |
what are some critiques of using gdp | many economists have argued that gdp should not be used as a proxy for overall economic success as it does not account for the informal economy does not count care work or domestic labor in the home ignores business to business activity and counts costs and wastes as economic activity among other shortcomings the bottom linereal gdp is an economic metric that is used to describe the economic output of a country within a specific year it reflects the value of all goods and services produced while factoring inflation into its calculation you may often hear it referred to by other names such as constant price gdp or inflation corrected gdp this is in contrast to nominal gdp this metric uses current prices to measure the output for goods and services | |
what is real income | real income is how much money an individual or entity makes after accounting for inflation and is sometimes called real wage when referring to an individual s income individuals often closely track their nominal vs real income to have the best understanding of their purchasing power understanding real incomereal income is an economic measure that provides an estimation of an individual s actual purchasing power in the open market after accounting for inflation it subtracts an economic inflation rate per dollar from an individual s income typically resulting in a lower value and decreased spending power 1deflation of prices can also occur which creates a negative inflation rate negative inflation or deflation will lead to a higher purchasing power of real income 2real income differs from nominal income which is not adjusted to account for fluctuating prices and living costs individuals often closely track their nominal vs real income to have the best understanding of their purchasing power 3overall real income is only an estimate of an individual s purchasing power since the formula for calculating real income uses a broad collection of goods that may or may not closely match the categories an investor spends within moreover entities may not spend all of their nominal income avoiding some of the real income s effects real income formulathere are several ways to calculate real income three basic real income formulas include the following inflation rate measuresall real income real wage formulas can integrate one of several inflation measures three of the most popular inflation measures for consumers include the consumer price index cpi cpi measures the average cost of a specific basket of goods and services including food and beverages education recreation clothing transportation and medical care in the united states the bureau of labor statistics bls publishes cpi numbers monthly and annually 4the personal consumption expenditure pce price index is a second comparable consumer price index it includes slightly different classifications for goods and services and also has its own adjustments and methodology nuances 5 the pce price index is used by the federal reserve for gauging consumer price inflation and making monetary policy decisions 6the gdp price index is one of the broadest measures of inflation since it considers everything produced by the u s economy excluding imports 7generally the three main price indexes will report relatively the same level of inflation however analysts of real income can choose any price index measure that they believe best fits their income analysis situation special considerations for investingmany individuals and businesses invest a significant portion of their income in risk free investment products and vehicles that match or exceed the economic inflation rate to mitigate the effects of inflation on their income several risk free investments offer a return of approximately 2 or more these products include high yield savings accounts money market accounts certificates of deposit treasuries and treasury inflation protected securities tips beyond that investors may be willing to take on slightly more risk to keep their income yielding at or above inflation for more sophisticated investors municipal and corporate bonds are often used for obtaining 2 returns beating inflation and helping income to grow steadily over time real wage rates | |
when following real wages there may be several statistics to consider a real wage rate can be a basic calculation of an individual s hourly weekly or annual rate after adjusting for inflation | having an expectation for a real wage rate can be just as important as a career expectation for a nominal wage rate the bls publishes a monthly real earnings report which can be helpful in keeping tabs on real wage rates the may 2022 real earnings report for example shows the real average hourly earnings rate across all surveyed workers on private nonfarm payrolls at 10 96 per hour a 2 5 decrease on may 2021 8the comprehensive bls report has been created using special methodologies individuals looking to calculate their own real wage rate may be better served by adapting the above real income formulas to their own individual situations for example a mid level manager with a nominal 60 000 per year salary might follow the cpi to calculate their real hourly weekly monthly and annual wage rate suppose the cpi reported an inflation rate of 2 4 using the simple formula wages 1 inflation rate real income this would result in an approximate real wage rate of 58 594 relative to the period in which the 60 000 was calculated calculating real wage rates on an hourly weekly and monthly basis can be more complex but still attempted the mid level manager could divide his nominal annual wage by the number of hours weeks and months per year with a subsequent adjustment for a monthly assessment a 60 000 per year salary would translate to 5 000 in nominal pay per month adjusting that by the cpi s monthly change let s say of 0 01 the 5 000 would have increased its purchasing power to 5 005 other takes on the real wage rate might look at the percentage of real to nominal wages or the real vs nominal wage growth rate cost of living indexes can also provide valuable information on real wage vs nominal wage rate expectations these indexes are used to make cost of living adjustments cola for workers insurance plans retirement plans and more purchasing poweroverall inflation s effect on wages will affect the purchasing power of an individual consumer when prices are rising in the marketplace but consumers are getting paid the same wage then a discrepancy is created which leads to an effect on purchasing power this is why real income decreases when inflation increases and vice versa | |
when inflation occurs a consumer must pay more for a fixed quantity of goods or services theoretically this is why savvy investors seek to hold a significant portion of their income in investments with a 2 return in that case with inflation at 2 they would be able to maintain their purchasing power at a constant level | for instance assume a consumer spends approximately 100 per month for a total of 1 200 per year on food during a year when inflation is rising at an annual rate of 1 also assume that the consumer saw no change in their wages a consumer with a 60 000 annual nominal salary would have lost approximately 600 of purchasing power over a year or one cent per dollar spent due to the effects of inflation in terms of their food purchases this means the same quantity of food cost them 12 more during the current year compared to the past year alternatively if this consumer isn t following a strict food budget they will likely spend approximately 101 per month or 1 212 to get the same amount of food they would have bought in the previous year | |
what is a real interest rate | a real interest rate is an interest rate that has been adjusted to remove the effects of inflation once adjusted it reflects the real cost of funds to a borrower and the real yield to a lender or to an investor a real interest rate reflects the rate of time preference for current goods over future goods for an investment a real interest rate is calculated as the difference between the nominal interest rate and the inflation rate real interest rate nominal interest rate rate of inflation expected or actual investopedia ryan oakleyunderstanding real interest rateswhile the nominal interest rate is the interest rate actually paid on a loan or investment the real interest rate is a reflection of the change in purchasing power derived from an investment or given up by the borrower the nominal interest rate is generally the one advertised by the institution backing the loan or investment adjusting the nominal interest rate to compensate for the effects of inflation helps to identify the shift in purchasing power of a given level of capital over time according to the time preference theory of interest the real interest rate reflects the degree to which an individual prefers current goods over future goods borrowers who are eager to enjoy the present use of funds show a stronger time preference for current goods over future goods they are willing to pay a higher interest rate for loaned funds similarly a lender who strongly prefers to put off consumption to the future shows a lower time preference and will be willing to loan funds at a lower rate adjusting for inflation can help reveal the rate of time preference among market participants special considerationsthe expected rate of inflation is reported to congress by the federal reserve fed among others reports include estimates for a minimum three year period most expected or anticipatory interest rates are reported as ranges instead of single point estimates 1as the true rate of inflation may not be known until an investment reaches maturity or its holding period ends the associated real interest rates must be considered anticipatory it s important that investors bear in mind current and expected inflation rates when they research where to put their money since the rate of inflation will eat away at the nominal rate of return avoid lower returning fixed income investments that could mean a negligible real rate of return in cases where inflation is positive the real interest rate will be lower than the advertised nominal interest rate for example if an investment such as a certificate of deposit cd is set to earn 4 in interest per year and the rate of inflation for the same time period is 3 the real interest rate earned on the investment will be 1 4 3 when purchasing power is taken into consideration the real value of the funds deposited in the cd will only increase by 1 per year not 4 if those funds were instead placed in a savings account with an interest rate of 1 and the rate of inflation remained at 3 then the real value or purchasing power of the funds in savings will actually decrease the real interest rate would be 2 after accounting for inflation 1 3 | |
what is purchasing power | purchasing power is the value of a currency expressed in terms of the number of goods or services that one unit of money can buy it is important because all else being equal inflation decreases the number of goods or services you can purchase for investments purchasing power is the dollar amount of credit available to a customer to buy additional securities against the existing marginable securities in the brokerage account purchasing power is also known as a currency s buying power | |
what is inflation | inflation is the decline of purchasing power of a given currency over time the rate of inflation or the rate of decline in purchasing power is reflected by the consumer price index cpi cpi measures the change in an average price of a basket of selected goods and services over a specific period of time the rise in the general level of prices often expressed as a percentage means that a unit of currency effectively buys less than it did in prior periods inflation can be contrasted with deflation which occurs when the purchasing power of money increases and prices decline | |
how does a real interest rate affect investment returns | a real interest rate is the nominal or stated interest rate less the rate of inflation for investments the inflation rate will erode the value of an investment s return by decreasing the rate of return for example if the rate of return for bonds you hold is 6 and the inflation rate is 3 then the real rate of return will be 3 not 6 that s because the interest rate of 6 is adjusted downward by 3 to account for the unfortunate power of inflation to erode value 6 3 3 the bottom linethe real interest rate is an interest rate that has been adjusted for inflation to reflect the real cost of funds to a borrower and the real yield to a lender or an investor it reflects the rate of time preference for current goods over future goods and is calculated as the difference between the nominal interest rate and the inflation rate | |
what is a real option | a real option is an economically valuable right to make or else abandon some choice that is available to the managers of a company often concerning business projects or investment opportunities it is referred to as real because it typically references projects involving a tangible asset such as machinery land and buildings as well as inventory instead of a financial instrument real options thus differ from financial options contracts since they involve real i e physical underlying assets and are not exchangeable as securities understanding real optionsreal options are choices that a company s management gives itself the option to make in order to expand change or curtail projects based on changing economic technological or market conditions factoring in real options affects the valuation of potential investments although commonly used valuations fail to account for potential benefits provided by real options using real options value rov analysis managers can estimate the opportunity cost of continuing or abandoning a project and make better decisions accordingly it is important to note that real options do not refer to a derivative financial instrument such as call and put options contracts which give the holder the right to buy or sell an underlying asset respectively instead real options are opportunities that a business may or may not take advantage of or realize for example investing in a new manufacturing facility may provide a company with real options for introducing new products consolidating operations or making other adjustments in response to changing market conditions when deciding whether to invest in the new facility the company should consider the real option value that the facility provides other examples of real options include possibilities for mergers and acquisitions m a or joint ventures real options valuationthe precise value of real options can be difficult to establish or estimate for instance real option value may be realized from a company undertaking socially responsible projects such as building a community center by doing so the company may realize a benefit that makes it easier to obtain necessary permits or approval for other projects however it s difficult to pin an exact financial value on such benefits in dealing with such real options a company s management team factors the potential for real option value into the decision making process even though the value is necessarily somewhat vague and uncertain of course the key difference between real options and derivatives contracts is that the latter often trades on an exchange and has a numerical value in terms of its price or premium real options on the other hand are far more subjective by using a combination of experience and financial valuations however management should get some sense of the value of the project being considered and whether it s worth the risk still valuation techniques for real options often appear similar to the pricing of financial options contracts where the spot price or the current market price refers to the current net present value npv of a project the net present value is the cash flow that s expected as a result of the new project but those flows are discounted by a rate that could otherwise be earned for doing nothing the alternative rate or discount rate might be the rate of a u s treasury bond for example if treasuries pay 3 then the project or the cash flows must yield a return of more than 3 otherwise it wouldn t be worth pursuing some valuation models use terminology from derivatives markets wherein the strike price corresponds to non recoverable costs involved with the project in the derivatives world the strike would be the price at which the options contract converts into the underlying security that it is based on similarly the expiration date of an options contract could be substituted with the time frame within which the business decision should be made options contracts also have a volatility component which measures the level of risk in an investment the higher the risk the more expensive the option real options must also consider the risk involved and it too could be assigned a value similar to volatility other methods of valuing real options include monte carlo simulations which use mathematical calculations to assign probabilities to various outcomes given certain variables and risks special considerationsreal options analysis is still often considered to be a heuristic a rule of thumb allowing for flexibility and quick decision making in a complex ever changing environment based on sound financial criteria the real options heuristic is simply the recognition of the value embodied in the flexibility of choosing among alternatives although their objective values cannot be mathematically determined with any degree of certainty even if a quantitative model is employed to value a real option the choice of the model itself is based on judgment and often a trial and error approach since the choices available can vary across firms and project managers having options affords the freedom to make optimal choices in decisions such as when and where to make a specific capital expenditure various management choices to make investments can give companies real options to take additional actions in the future based on existing market conditions in short real options are about companies making decisions and choices that grant them the greatest amount of flexibility and potential benefit regarding possible future decisions or choices the choices that corporate managers face that typically fall under real options analysis are under three categories of project management real options are most appropriate when the economic environment and market conditions relating to a particular project are highly volatile yet flexible stable or rigid environments will not benefit much from rov and should use more traditional corporate finance techniques instead similarly rov is applicable only when a firm s corporate strategy lends itself to flexibility has sufficient information flow and has sufficient funds to cover potential downside risks associated with real options real world example of real optionsmcdonald s corp mcd has restaurants in more than 100 countries let s say the company s executives are mulling the decision to open additional restaurants in russia the expansion would fall under the category of real option to expand the investment or capital outlay would need to be calculated including the cost of the physical buildings land staff and equipment however mcdonald s executives would need to decide if the revenue earned from the new restaurants will be enough to counter any potential country and political risk which is difficult to value the same scenario could also produce a real option to wait or defer opening any restaurants until a particular political situation resolves itself perhaps there s an upcoming election and the result could impact the stability of the country or the regulatory environment | |
how do real options work for a company | with real options a business s management gives itself the option to expand change or curtail projects based on changing economic market or technological conditions factoring in real options affects the valuation of potential investments however commonly used valuations fail to account for the potential benefits that real options provide | |
how are real options valued | in dealing with real options a company s management team factors the potential for real option value into decision making although the value is somewhat vague and uncertain valuation techniques for real options often appear similar to pricing financial options contracts where the spot price or current market price refers to the current net present value npv of a project | |
when are real options most appropriate | real options are most appropriate when the economic environment and market conditions relating to a particular project are highly volatile yet flexible stable or rigid environments will not benefit much from real options value rov analysis and should use more traditional corporate finance techniques instead the bottom linea real option gives management of a company the right but not the obligation to undertake certain business opportunities or investments it is called a real option because it usually references projects involving a tangible asset such as machinery land and buildings as well as inventory instead of a financial instrument | |
what is real property | real property is a parcel of land and structures that are permanently attached to the land the owner of real property has all the rights of ownership including the right to possess sell lease and enjoy the land real property may be classified according to its general use as residential commercial agricultural industrial or special purpose to understand if you have the right to sell your home you need to know which rights you possess or don t possess in connection with the property | |
how real property is defined | to understand how real property is defined it s helpful to start with land and real estate land is the earth s surface extending downward to the center of the earth and upward to infinity including everything that is permanently attached by nature or at least attached for the foreseeable future such as boulders trees and water land also includes the minerals below the earth s surface and the airspace above the land 1in contrast real estate is defined as the land at above and below the earth s surface including everything that s permanently attached to it whether natural or artificial therefore the definition of real estate extends to all artificial permanent improvements to the land such as streets utilities sewers fences and buildings real property is a broader term than real estate as it encompasses the interests benefits and rights inherent in the ownership of real estate it includes the physical land the surface as well as what lies below and above it everything that is permanently attached to it whether natural or artificial plus all the rights of ownership including the right to possess sell lease and use the land each state has its own laws regarding what real property is and how to handle its sale for the most part real property isn t subject to federal laws because real estate by definition doesn t move across state borders estates in real propertythe amount and kind of interest a person has in real property is called an estate in land estates in land are broken down into two major classifications freehold estates and non freehold estates freehold estates involve ownership they have an indefinite duration and can last for a lifetime or forever examples of freehold estates include 2unlike a fee simple estate a life estate isn t considered an estate of inheritance non freehold estates involve leases they can t be passed to an heir and they exist without seisin or without ownership also known as a leasehold estate non freehold estates are created through written and oral leases and rental agreements examples of non freehold estates include 3real property vs personal propertythe law makes a clear distinction between real property and personal property real property is immovable it includes the land everything that is permanently attached to it and the rights that run with the land personal property on the other hand is movable it is defined as everything that isn t real property such as your clothes furniture cars boats and any other movable items that aren t attached to real estate real property vs real estatereal estate is land at above and below the earth s surface including everything permanently attached to it whether natural or artificial real property is everything included in real estate plus the rights of ownership including the right to possess sell lease and enjoy the land | |
what is real estate vs real property | the terms real estate and real property are used interchangeably but real property is actually a broader term real estate is defined as land and everything attached to it real property extends to the interests benefits and rights inherent in the ownership of real estate | |
what are some examples of real property | a natural formation like a hill or a pond can be real property an artificial addition such as a house a driveway or a garden shed can also be considered real property if you own the land that structures are situated on you have the right to use manage and dispose of the structures these rights are derived from english common law and they are constrained by state and local laws 4 | |
is a car real property | a car is tangible personal property not real property as the car can be moved unlike most other tangible personal property a car can be used to secure a loan a car loan is secured by the vehicle just as a mortgage is secured by a house the bottom linereal estate is land at above and below the earth s surface including all things permanently attached to it whether natural or artificial the owner of real property has all the rights of ownership including the right to possess sell lease and enjoy that land there are several kinds of estates in real property the term real estate is essentially the same as real property on the other hand personal property is defined as all possessions that don t fit the definition of real property such as clothes cars and furniture | |
what is the real rate of return | the real rate of return is the annual percentage of profit earned on an investment adjusted for inflation therefore the real rate of return accurately indicates the actual purchasing power of a given amount of money over time adjusting the nominal return to compensate for inflation allows the investor to determine how much of a nominal return is real return in addition to adjusting for inflation investors also must consider the impact of other factors such as taxes and investing fees to calculate real returns on their money or to choose among various investing options understanding real rate of returnthe real rate of return is calculated by subtracting the inflation rate from the nominal interest rate 1examples of real rate of returnassume a bond pays an interest rate of 5 per year if the inflation rate is currently 3 per year then the real return on your savings is only 2 in other words even though the nominal rate of return on your savings is 5 the real rate of return is only 2 which means the real value of your savings increases by only 2 in a year considered another way assume you have saved 10 000 to buy a car but decide to invest the money for a year before buying to ensure that you have a small cash cushion left over after getting the car earning 5 interest you have 10 500 after 12 months however because prices increased by 3 during the same period due to inflation the same car now costs 10 300 consequently the amount of money that remains after you buy the car which represents your increase in purchasing power is 200 or 2 of your initial investment this is your real rate of return as it represents the amount that you gained after accounting for the effects of inflation real rate of return vs nominal rate of returninterest rates can be expressed in two ways as nominal rates or as real rates the difference is that nominal rates are not adjusted for inflation while real rates are 2 as a result nominal rates are almost always higher except during those rare periods when deflation or negative inflation takes hold in the late 1970s and early 1980s the profits from double digit interest rates were eaten up by the effects of double digit inflation an example of the potential gap between nominal and real rates of return occurred in the late 1970s and early 1980s double digit nominal interest rates on savings accounts were commonplace but so was double digit inflation prices increased by 11 25 in 1979 and 13 55 in 1980 34 therefore real rates of return were significantly lower than their nominal rate counterparts so should an investor rely on the nominal rate or the real rate real rates give an accurate historical picture of how an investment performed but the nominal rates are what you ll see advertised on an investment product the problem with real rate of return is that you don t know what it is until it has already happened that is inflation for any given period is a trailing indicator which can only be calculated after the relevant period has ended in addition the real rate of return isn t entirely accurate until it also accounts for other costs such as taxes and investing fees | |
what is trailing | trailing refers to the property of a measurement indicator or data series that reflects a past event or observation it is usually attached to a specified time interval by which the data trail or over which that data is aggregated summed or averaged trailing data and indicators are used to reveal underlying trends but can delay recognition of trend turning points trailing can also refer to a type of stop order used by traders | |
what is the difference between a real or a nominal interest rate | a real interest rate is an interest rate that has been adjusted to remove the effects of inflation to reflect the real cost of funds to the borrower and the real yield to the lender or to an investor a nominal interest rate refers to the interest rate before taking inflation into account 2 nominal can also refer to the advertised or stated interest rate on a loan without taking into account any fees or compounding of interest | |
what is inflation | inflation is the decline of purchasing power of a given currency over time a quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time the rise in the general level of prices often expressed as a percentage means that a unit of currency effectively buys less than it did in prior periods | |
what is real time | real time is when a system relays information to a user at a speed that is near instantaneous or has a short delay from when the event occurred online brokerages often provide a real time data feed that displays stock quotes and their respective real time changes with a very insignificant lag time so that clients can base their investing decisions on the most up to date information understanding real timewhile many financial websites do offer free stock quotes to the general public many of these feeds are not real time feeds and may be delayed up to 20 minutes therefore when viewing stock quotes from any financial website be aware of the time that is posted near the stock quote to verify whether the quote is actually in real time possessing accurate real time quotes is especially important for traders as even the smallest time discrepancy between a provided quote and the real time situation can change a profitable position into a loss for rapid intra day traders especially it can be critical to get real time quotes instead of delayed quotes real time stock quotes vs delayed stock quotesstock quotes reflect the results of actual trading on stock market exchanges such as the new york stock exchange or nasdaq investors and traders can get quotes on the dow jones industrial average other indices or individual stocks from a number of financial news sources however some financial news services don t report real time information and instead delay stock quotes for 15 or 20 minutes 1the prices of actively traded stocks can fluctuate dramatically from minute to minute or from second to second that s why knowing the current price is imperative in a rapidly rising or falling market also known as a fast market even real time quotes can have a hard time keeping up in that market scenario a quote that s delayed 15 or 20 minutes is virtually useless as a stock s price could have moved by a significant percentage in that time frame delayed quotes are usually enough information for a casual investor who isn t looking to time the market for example if a trader has a long term portfolio of stocks they don t intend to sell they don t need up to the second price information even delayed stock quotes provide a general ballpark of where stocks and indexes are and whether they are trending up or down providing real time quotes takes effort and technology thus this service has a cost if firms don t want to absorb this cost they ll only offer delayed quotes reuters for example provides lots of financial information but its stock quotes are delayed at least 15 minutes 2 financial news services often offer real time quotes as a premium subscription service | |
what is real time gross settlement rtgs | the term real time gross settlement rtgs refers to a funds transfer system that allows for the instantaneous transfer of money and or securities rtgs is the continuous process of settling payments on an individual order basis without netting debits with credits across the books of a central bank once completed real time gross settlement payments are final and irrevocable in most countries the systems are managed and run by their central banks | |
when you hear the term real time it means the settlement happens as soon as it is received so in simpler terms the transaction settles in the receiving bank immediately after it is transferred from the sending bank gross settlement means transactions are handled and settled individually so multiple transactions aren t bunched or grouped together this is the basis of a real time gross settlement system | an rtgs system is generally used for large value interbank funds transfers operated and organized by a country s central bank these transfers often require immediate and complete clearing as mentioned above once transactions are settled they cannot be reversed in 1970 the u s fedwire system was launched it was the first system resembling a real time gross settlement system it was an evolution of the telegraph based system used to transfer funds electronically between u s federal reserve banks 1the british system called the clearing house automated payment system chaps is currently run by the bank of england france and other eurozone nations use a system called trans european automated real time gross settlement express transfer system target2 other developed and developing countries have also introduced their own rtgs type systems 23real time gross settlement lessens settlement risk also referred to as delivery risk overall as interbank settlement usually occurs in real time throughout the day instead of simply all together at the end of the day this eliminates the risk of a lag in completing the transaction rtgs can often incur a higher charge than processes that bundle and net payments rtgs vs bankers automated clearing services bacs a real time gross settlement system is different from net settlement systems such as the united kingdom s bacs payment schemes limited which was previously known as the bankers automated clearing services bacs transactions that take place between institutions with bacs are accumulated during the day at the close of business a central bank adjusts the active institutional accounts by the net amounts of the funds exchanged 4rtgs does not require an actual physical exchange of funds a central bank will often adjust the accounts of the sending and receiving bank in electronic form for example sender bank a s balance will be reduced by 1 million while recipient institution bank b s balance will be increased by 1 million 5benefits of rtgsrtgs systems increasingly used by central banks worldwide can help minimize the risk to high value payment settlements among financial institutions although companies and financial institutions that deal with sensitive financial data typically have high levels of security in place to protect information and funds the range and nature of online threats are constantly evolving rtgs type systems help protect financial data by making it vulnerable to hackers for a briefer time window real time gross settlement can allow a smaller window of time for critical information to be vulnerable thus helping mitigate threats two common examples of cybersecurity threats to financial data are social engineering or phishing tricking people into revealing their information and data theft whereby a hacker obtains and sells data to others 6 | |
what is the real time gross settlement fee | the fee for real time gross settlement will vary depending on the institution country in which the settlement occurs as well as the size of the transfer there are times when the fees can be waived by the institution | |
what is an example of a real time gross settlement system | an example of a real time gross settlement system would be when a customer has their bank send a transfer of funds to another bank via the rtgs and the transfer happens instantaneously if this transfer was done via automated clearing house ach the transfer may take a few days to clear | |
what is the difference between net settlement and real time gross settlement | the difference between net settlement and real time gross settlement rtgs is that net settlement involves aggregate data that is processed and settled at the end of the day whereas rtgs involves data with individual transactions in real time processed and settled instantly the bottom linereal time gross settlement rtgs is a key component of the financial system settling interbank payments continuously allowing for the instantaneous transfer of money securities rtgs systems reduce the risk to financial institutions in regard to high value transfers | |
what is a real time quote rtq | a real time quote rtqs is the display of the actual price of a security at that very moment in time quotes are the price of a stock or security displayed on various websites and ticker tapes in most cases these figures are not real time numbers of where the securities are trading but are delayed quotes delayed quotes unlike real time quotes may lag the real trading market by between 15 and 20 minutes real time quotes are instantaneous with no delay understanding a real time quotereal time stock quotes sometimes known as quote streaming services are increasingly offered as a free add on with many web based financial sites and online brokerages however some providers will still charge an additional fee to gain access to them also real time pricing information for options and other securities may incur additional fees as they are intended primarily for professional traders and firms | |
how a real time quote works | a standard quote on any security consists of a bid price and an ask or offer price and is a two way pricing structure in this structure the bid price is the most any buyer is willing to pay for the share or the security conversely the asking price is the least amount the seller is willing to take for the share the bidding price is what the sellers would receive for the security and the asking offer price is what buyers must pay for the security for example the quote for a share of xyz may appear as 23 25 to 23 30 in this case the most the buyer will pay is 23 25 and the least the seller will accept is 23 30 further the more volume that trades on a particular security will bring the bid and ask prices closer together special considerationshistorically price quotes arrived via ticker tape which relied on telegraph technology over time quotes began to be disseminated daily in newspapers and during television broadcasts brokerage customers who wanted a stock quote would rely on telephones where a broker would physically call down to a stock exchange and request a quote with the rise of internet based online trading the cost of providing real time quotes dropped significantly and soon became ubiquitous as of the early 2010s stock exchanges provide quotes to the public which vary with the amount of information available traders and investors using electronic trading methods may receive level i ii or iii quotes as the quotes move upward in level more information is provided however additional information will come at an additional cost providing real time quotes takes effort and technology and as such costs more if firms do not want to absorb this cost they will only offer delayed quotes reuters for example provides quite a bit of financial information but its stock quotes lag the market by 10 to 20 minutes as of 2021 1 financial news services often offer real time quotes as a premium subscription service unless you re a day trader or high frequency trader delayed quotes are usually sufficient for monitoring a portfolio or placing an order for a stock you plan to hold for the long term advantages and disadvantages of real time quotesreal time quotes let investors or traders know the exact price for a stock they are trading at a moment to moment rate in this way they may have a far better idea of the price they will pay when having their order filled if they base their cost on a delayed quote they could find they significantly overpaid or luckily underpaid for the shares in a rapidly rising or falling market also known as a fast market even real time quotes can have a hard time keeping up in that market scenario a quote delayed by between 15 and 20 minutes is virtually useless as a stock could have moved by a significant percentage in that time frame delayed quotes are usually enough information for a casual investor who isn t looking to time the market for example if a trader has a long term portfolio of stocks and they don t intend to sell immediately they won t need up to the second price information delayed quotes provide a general ballpark of where stocks and indexes are and whether they are trending up or down but with the advent of ultra fast high frequency trading hft the need for precise real time price data is increasingly vital for the people who trade using this method these traders rely on algorithms to the order of milliseconds they use sophisticated communications technologies such as fiber optics millimeter wave microwave transmission and exchange co location techniques to obtain ultra real time information as well as send orders which can process immediately in the market | |
what is the realization multiple | the realization multiple is a private equity measurement that shows how much has been paid out to investors the realization multiple measures the return that is realized from the investment private equity funds are unique in that they hold assets that are pulled together from all sorts of illiquid sources including leveraged buyouts lbo start ups and so on the realization multiple is found by dividing the cumulative distributions from a fund company or project by the paid in capital the realization multiple is also referred to as distributed to paid in capital dpi the formula for the realization multiple isimage by sabrina jiang investopedia 2021 | |
how realization multiple works | the realization multiple is popular among venture capitalists and private equity fund investors this is because it focuses on what has actually been paid out to investors if a private equity fund is paying out money to investors year after year its realization multiple will climb as there are more distributions in the books this allows a private equity investor to easily spot a fund that is successful at returning money back to its investors realization multiple as part of the wholethe realization multiple does not tell the whole story of a private equity fund s performance it is combined with other measures like the investment multiple the paid in capital pic the total value to paid in multiple tvpi and the residual value to paid in multiple rvpi of course the fund s internal rate of return since inception is also used as a key measure investors are essentially searching for the funds that generate a large amount of return investment multiple and aren t shy about returning some of it to investors on a regular basis as with most private equity measures the realization multiple ignores the time value of money this differentiates the realization multiple from other valuation methods such as internal rate of return or net present value private equity funds are difficult to evaluate due to the types of investments they hold there isn t a deep market that can establish valuation on a daily basis so investors have to make guesses and leaps of faith when it comes to putting a number on the residual value the realization multiple strips some of the uncertainty away and zeros in on what investors have seen from this fund in actual returned funds and by extension what is reasonable to expect in the future the caveat is that in the world of private equity investing past events only influence future events to a limited extent all it takes is for a financing shift and lbos or heavily leveraged startups have a steeper hill to climb before a future exit strategy through an initial public offering ipo | |
what is a realized gain | a realized gain results from selling an asset at a price higher than the original purchase price it occurs when an asset is sold at a level that exceeds its book value cost while an asset may be carried on a balance sheet at a level far above cost any gains while the asset is still being held are considered unrealized as the asset is only being valued at fair market value if selling an asset results in a loss there is a realized loss instead a realized gain can be compared with an unrealized gain | |
how realized gains work | realized gains and unrealized gains vary considerably realized gains are those that have been actualized by selling an existing position for more than what was paid for it an unrealized paper gain on the other hand is one that has not been realized yet realized gains result in a taxable event but unrealized gains are typically not taxed they add to an asset s originally reported book value at the time of purchase and can occur on all types of assets and investments held by a company balance sheet eliminationrealized gains may occur through the sale of an asset when a company chooses to eliminate it from the balance sheet asset sales can occur for various reasons and purposes and are reported on the financial statements of a company during the period in which the asset sale takes place asset sales are regularly monitored to ensure the asset is sold at fair market value or arm s length price this regulation ensures companies are valuing the sale appropriately in the marketplace and takes into consideration whether the asset is sold to a related or unrelated party | |
when an asset is sold a realized profit is achieved and the firm predictably sees an increase in its current assets and a gain from the sale the realized gain from the sale of the asset may lead to an increased tax burden since realized gains from sales are typically taxable income this is one drawback of selling an asset and turning an unrealized paper gain into a realized gain | in most business cases companies do not incur any tax until a realized and tangible profit occurs realized vs unrealized gainswhile realized gains are actualized an unrealized gain is a potential profit that exists on paper resulting from an investment it is an increase in the value of an asset that has yet to be sold for cash such as a stock position that has increased in value but still remains open a gain becomes realized once the position is sold for a profit | |
when unrealized gains present it usually means an investor believes the investment has room for higher future gains otherwise they would sell now and recognize the current gain additionally unrealized gains sometimes come about because holding an investment for an extended time period lowers the tax burden of the gain | for example if an investor holds a stock for longer than one year their tax rate is reduced to the long term capital gains tax 1 further if an investor wants to move the capital gains tax burden to another tax year they can sell the stock in january of a proceeding year rather than selling in the current year investors should also note the distinction between realized gains and realized income realized income refers to income that you have earned and received such as income from wages or a salary as well as income from interest or dividend payments | |
what is a realized loss | a realized loss is the loss that is recognized when assets are sold for a price lower than the original purchase price realized loss occurs when an asset that was purchased at a level referred to as cost or book value is then disbursed for a value below its book value understanding realized loss | |
when an investor buys a capital asset an increase or decrease in the value of the security does not translate to a profit or loss the investor can only make a claim to a profit or loss after he has sold the security at fair market value in an arm s length transaction 1 | real world example of realized loss for investorsfor example assume an investor purchases 50 shares of exwhyzee xyz at 249 50 per share on march 20 from this purchase date to april 9 the value of the stock declined by about 13 7 to 215 41 however the investor only has a realized loss if he actually sells at the depressed price otherwise the decline in value is simply an unrealized loss which only exists on paper realized losses unlike unrealized losses can affect the amount of taxes owed a realized capital loss can be used to offset capital gains for tax purposes from our example above the investor after selling his xyz stocks realized a loss of 50 x 249 50 215 41 1 704 50 suppose he realized a profit on aybeecee abc which he purchased for 201 07 and sold for 336 06 during the same tax year if he purchased and sold 50 abc shares his capital gain on the transaction will be recognized as 50 x 336 06 201 07 6 749 50 applying the realized loss to this gain means that the investor will only owe taxes on 6 749 50 1 704 50 5 045 rather than the entire capital gains amount in addition if the realized losses for a given tax year exceed the realized gains up to 3 000 of the remaining losses can be deducted from the taxpayer s taxable income also if net losses exceed the given 3 000 limit the remainder can be carried forward to future years 2 this practice is called tax loss harvesting and discount brokers have added features to their desktop and mobile apps in recent years to help investors with this process | |
how realized loss works for businesses | a realized loss occurs when the sale price of an asset is lower than its carrying amount although the asset may have been held on the balance sheet at a fair value level below cost the loss only becomes realized once the asset is off the books an asset is removed from the books when it is sold scrapped or donated by the company one upside to a realized loss is the possible tax advantage in most instances a portion of the realized loss may be applied against a capital gain or realized profit to reduce taxes 2 this may be quite desirable for a company looking to limit its tax burden and firms may actually go out of their way to realize losses in periods where their tax bill is expected to be higher than wished in effect a business may choose to realize losses on as many assets as possible when it would otherwise have to pay taxes on realized profits or capital gains | |
what is realized yield | realized yield is the actual return earned during the holding period for an investment it may include dividends interest payments and other cash distributions the term realized yield can be applied to a bond sold before its maturity date or a dividend paying security generally speaking the realized yield on bonds includes the coupon payments received during the holding period plus or minus the change in the value of the original investment calculated on an annual basis understanding realized yieldthe realized yield on investments with maturity dates is likely to differ from the stated yield to maturity ytm under most circumstances one exception occurs when a bond is purchased and sold at face value which is also the redemption price of the bond at maturity for example a bond with a coupon of 5 that is purchased and sold at face value delivers a realized yield of 5 for the holding period the same bond redeemed at face value when it matures provides a yield to maturity of 5 in all other circumstances realized yields are calculated based on payments received and the change in the value of principal relative to the amount invested the realized yield is what a bond market participant actually gets which is not necessarily the stated yield to maturity given identical credit quality a one year bond with a 3 coupon and a principal of 100 selling at 102 is roughly equivalent to a one year bond with a 1 coupon selling at face value we express this equivalence by stating that both of these bonds have a yield to maturity of about 1 however suppose the market interest rate falls half a percentage point one month later and one year bond prices rise about 0 5 in response to lower rates if the investor sells the bonds after only that one month without collecting any coupon payments the result is a realized yield of a little over 6 on an annual basis realized yield is also an exceptionally useful concept for evaluating high yield bonds realized yield gives investors a way to deal with the fact that some high yield bonds almost always default the realized yield of a high yield bond fund is likely to be lower than its yield to maturity because of defaults an example will help to illustrate how realized yield works in the high yield bond market suppose that interest rates and overall default risk stay the same for a particular year in that year one year treasuries are offering a yield to maturity of 0 5 at the same time a high yield bond fund has a yield to maturity of 5 but 3 of the bonds default during the year the realized yield for the high yield bond fund was just 2 because of the defaults compared to the yield to maturity of 5 on the other hand the realized yield was 0 5 for the treasuries which was identical with their yield to maturity realized yield vs realized returnrealized yield like realized return is simply how much money the investor actually made in the bond market it is common to use the terms realized yield and realized return interchangeably however the term realized return is typically used instead of realized yield in the stock market high dividend yield stocks are the major exception types of realized yieldsrealized yield is the total return when an investor sells a bond before maturity for example a bond maturing in three years with a 3 coupon purchased at face value of 1 000 has a yield to maturity of 3 if the bond is sold precisely one year after purchase at 960 the loss of principal is 4 the coupon payment of 3 brings the realized yield to a negative 1 instead suppose such a bond is sold after a year at 1 020 for a 2 gain in principal in this case the realized yield increases to 5 due to the 3 coupon payment certificate of deposit investors who cash out before the maturity date often have to pay a penalty on a two year cd the typical charge for early withdrawal is six months of interest for example say an investor who cashes out a two year cd that pays 1 after one year accrues 1 000 of interest the penalty of six months equates to 500 after paying this fee the investor gets 500 over one year for a realized yield of 0 5 the calculation for realized yield also applies to exchange traded funds etfs and other investment vehicles without maturity dates for example an investor who holds an etf paying 4 interest for exactly two years and sells for a 2 gain earned 4 per year in interest the increase in principal is spread out over the two year holding period for a 1 gain per year bringing the realized yield to 5 per year | |
what is a realtor | a realtor is a real estate professional and a national association of realtors nar member the nar defines the term realtor as a federally registered collective membership mark that identifies a real estate professional who is a member of the association and subscribes to its code of ethics 1nar requirementsrealtors are licensed professionals who facilitate transactions between buyers and sellers and are members of nar all realtors are licensed real estate professionals but not all real estate agents are considered realtors professionals who hold the title of realtor include agents who work as residential and commercial real estate brokers salespeople property managers appraisers counselors and other real estate professionals the term realtor is a registered trademark 1in 2024 1 5 million members of the nar include real estate agents brokers and associate brokers 2 realtors must belong to a local association or board and a state association 3realtors are expected to be experts in their field and must follow the nar s code of ethics with clients customers the public and other realtors among its many requirements the code of ethics says that realtors shall avoid exaggeration misrepresentation or concealment of pertinent facts relating to the property or the transaction realtors must pledge themselves to protect and promote the interests of their client 4new rules for the national association of realtors expected to take effect in july 2024 may lower commissions for home buyers and sellers if a federal court approves the changes the standard 6 commission ends and sellers no longer have to propose compensation to prospective buyers and their agents nar will also require brokers to enter into written agreements with their buyers to help consumers understand what services will be provided and at what cost 5using the realtor trademarkthe nar maintains stringent rules on the use of the realtor trademark professionals who hold membership as a realtor or realtor associate on a member board are licensed to use realtor trademarks in connection with their name and the name of their real estate business the realtor trademark is prohibited from being used as part of the legal corporate name of members 6 according to the nar this is done to avoid the legal issues involved with a corporate name change if a member were suspended or expelled from the association and lost the right to use the trademark 7nar s guidelines state that if a qualified member uses the realtor trademark as part of their name it must appear in all capital letters and be set off from the member s name by punctuation the nar does not use the realtor trademark with descriptive terms or as a description of the vocation the way terms such as real estate broker agent and licensee are used the association also says that realtor trademarks are not to be used as a designation of the licensed status of a professional 86 | |
when was the national association of realtors started | the nar was founded as the national association of real estate exchanges in 1908 at the time it had 120 members 19 boards and a single state association 1 | |
what is the realtor code of ethics | the code of ethics professional standards is a set of rules focused on fair and honest behavior that members pledge to abide by the code of ethics holds members to a high moral standard 4 | |
how are real estate agents different from realtors | real estate agents are licensed by their state to help people buy and sell real estate realtors are real estate agents who have opted to become members of the national association of realtors the bottom linea realtor is a national association of realtors nar member professionals who may hold the title of realtor include agents who work as residential and commercial real estate brokers salespeople and property managers realtors must abide by the nar s code of ethics | |
what is rebalancing | rebalancing refers to the process of returning the values of a portfolio s asset allocations to the levels defined by an investment plan those levels are intended to match an investor s tolerance for risk and desire for reward over time asset allocations can change as market performance alters the values of the assets rebalancing involves periodically buying or selling the assets in a portfolio to regain and maintain that original desired level of asset allocation take a portfolio with an original target asset allocation of 50 stocks and 50 bonds if the stocks prices rose during a certain period of time their higher value could increase their allocation proportion within the portfolio to say 70 the investor may then decide to sell some stocks and buy bonds to realign the percentages back to the original target allocation of 50 50 | |
how rebalancing works | portfolio rebalancing aims to protect investors from exposure to undesirable risks while providing exposure to reward it can also ensure that a portfolio s exposure remains within the portfolio manager s area of expertise there are times when a stock s price performance can vary more dramatically than that of bonds therefore a portfolio s percentage of equity related assets should be assessed as market conditions change if the value of equities in a portfolio causes the allocation in stocks to rise above their preset percentage a rebalancing may be in order that would involve selling some shares of stock to lower the overall percentage of equities in the portfolio investors may also wish to adjust their overall portfolio risk to meet changing financial needs for instance an investor who needs a greater potential for return might increase the allocation in assets that involve higher risk such as equities to improve that potential or if income becomes more important than it was before the allocation of bonds could be increased some investors may mistakenly understand rebalancing to refer to adjusting for an even distribution of assets however a 50 50 stock and bond split is not required a portfolio s target allocation of assets just as easily could be 70 stocks and 30 bonds 40 stocks and 60 bonds or 10 cash 40 stocks and 50 bonds the allocation depends on the goals and needs of an investor while there is no required schedule for rebalancing a portfolio it s recommended that investors examine allocations at least once every year investors don t have to rebalance but generally that s ill advised rebalancing gives investors the opportunity to sell high and buy low taking the gains from high performing investments and reinvesting them in areas that are expected to see notable growth an investment plan where asset allocations and rebalancing are defined can range from a simple idea or strategy created by an individual to a multi page package developed by a portfolio manager an investment plan can help ensure that every investor takes needed actions including rebalancing and avoids inappropriate steps that could affect a portfolio s return negatively types of rebalancingcalendar rebalancing is the most rudimentary rebalancing approach this strategy involves analyzing and adjusting the investment holdings within the portfolio at predetermined times many long term investors rebalance once a year other types of investors with different outlooks and goals may rebalance quarterly or even monthly weekly rebalancing could be overly expensive and unnecessary the ideal frequency of rebalancing must be determined based on an investor s time constraints threshold for transaction costs and allowance for value drift advantages of calendar rebalancing over more responsive methods are that it is less time consuming and costly for the investor since it involves fewer rebalancing occasions and potentially fewer trades however a downside is that it does not call for rebalancing at other dates even if the market moves significantly a more responsive approach to rebalancing focuses on the allowable percentage composition of an asset in a portfolio this is known as a constant mix strategy with bands or corridors every asset class or individual security is given a target weight and a corresponding tolerance range for example an allocation strategy might include the requirement to hold 30 in emerging market equities 30 in domestic blue chips and 40 in government bonds with a corridor of 5 for each asset class therefore emerging market and domestic blue chip holdings can both fluctuate between 25 and 35 at the same time 35 to 45 of the portfolio must be allocated to government bonds when the weight of any one holding moves outside of its allowable band the entire portfolio is rebalanced to reflect the initial target composition the most intensive rebalancing strategy commonly used is constant proportion portfolio insurance cppi is a type of portfolio insurance that allows the investor to set a floor on the dollar value of their portfolio and structure the asset allocation on it the asset classes in cppi are styled as a risky asset such as equities or mutual funds and a conservative asset of either cash cash equivalents or treasury bonds the percentage allocated to each depends on a cushion value defined as the current portfolio value minus some floor value and a multiplier coefficient the greater the multiplier number the more aggressive the rebalancing strategy the outcome of the cppi strategy is somewhat similar to that of buying a synthetic call option that does not use actual option contracts cppi is sometimes referred to as a convex strategy smart beta rebalancing is a periodic rebalancing similar to the regular rebalancing that indexes undergo to adjust to changes in stock value and market capitalization smart beta strategies take a rules based approach to avoid the market inefficiencies that creep into index investing due to the reliance on market capitalization smart beta rebalancing uses additional criteria such as value as defined by performance measures like book value or return on capital to allocate the holdings across a selection of stocks this rules based method of portfolio creation adds a layer of systematic analysis to the investment that simple index investing lacks although smart beta rebalancing is more active than simply using index investing to mimic the overall market it is less active than stock picking one of the key features of smart beta rebalancing is that emotions are taken out of the process depending on how the rules are set up an investor may end up trimming exposure to their top performers and increasing exposure to less stellar performers this runs counter to the old adage of letting your winners run but the periodic rebalancing realizes the profits regularly rather than trying to time market sentiment for maximum profit smart beta can also be used to rebalance across asset classes if the proper parameters are set in this case the risk weighted returns are often used to compare different types of investments and adjust exposure accordingly examples of rebalancingone of the most common areas investors look to rebalance is the allocations within their retirement accounts asset performance impacts the overall value and many investors prefer to invest more aggressively at younger ages and more conservatively as they approach retirement age often the portfolio is at its most conservative once the investor prepares to draw out the funds to supply retirement income so over the years a portfolio may be rebalanced to reflect an increasingly greater allocation in fixed income securities depending on market performance investors may find a large number of assets held within one area for example should the value of stock x increase by 25 while stock y only gained 5 a large amount of the value in the portfolio is tied to stock x | |
should stock x experience a sudden downturn the portfolio will suffer higher losses by association rebalancing lets the investor redirect some of the funds currently held in stock x to another investment be that more of stock y or purchasing a new stock entirely | by having funds spread out across multiple stocks a downturn in one will be partially offset by the activities of the others which can provide a level of portfolio stability advantages and disadvantages of rebalancing | |
what does rebalancing a portfolio mean | it means selling and buying the necessary securities to bring the value of each allocation in a portfolio back to the level established by an investment plan | |
does rebalancing have costs | yes it does it involves the fees related to the transactions to purchase and sell securities it can also involve the cost of performance for example to rebalance you might sell securities that have increased in value and pushed your allocations out of whack however you could miss out on a continued upswing in prices that those securities experience by making rebalancing part of an investment plan that you commit to you ll be aware of and can accept these and other potential costs in advance | |
how often should i rebalance | that depends on your investment goals risk tolerance and financial needs for example long term investors who take a buy and hold approach to the markets might consider reviewing their allocations once a year with their financial advisors to see if rebalancing is warranted other investors with shorter term goals may wish to rebalance more frequently to be sure they stay on track to meet those goals | |
what is a rebate | in a short sale transaction a rebate is a portion of interest or dividends that is paid by a short seller to the owner of the stock or bond shares being sold short short selling requires a margin account broadly speaking a rebate is a sum of money that is credited or returned to a customer on completion of a transaction a rebate may offer cash back on the purchase of a consumer product or service this may be a flat rate rebate which is automatically subtracted from the purchase price or a conditional rebate which is only valid under certain conditions such as buy one get one free some conditional rebates require the purchaser to submit a form along with proof of payment to the company offering the cash back understanding rebatesbusinesses offer rebates for many reasons mainly because they are a potent marketing tool drawing customers who are attracted to the prospect of receiving cash back on expensive items while companies sometimes take a loss on a rebated product they often find a way to squeeze out a profit on them and even when they do take a loss customers who purchase items with rebates may buy other items in the store giving the business a net profit some companies price protect certain products by offering rebates on others hoping that sales of products with rebates will allow them to keep other products at a higher price point the mail in rebate is one of the most familiar types of consumer rebates since they require a certain amount of effort some consumers fail to take advantage of them many businesses take this into account when deciding to offer a mail in rebate knowing in advance that only a certain proportion of customers will take the cash back companies can estimate an average price reduction less than the rebate amount rebates are commonly offered on sales of new vehicles typically the vehicle manufacturer pays for the rebate rather than the dealer the manufacturer gives money to the dealer who then transfers it to the consumer by law dealers must pass on the full amount of the rebate to the customer provided the customer qualifies for it 1rebates sometimes harm the resale value of vehicles since they effectively lower their sticker price rebates vs discounts and reduced interest ratesrebates are collected after payment while discounts are taken before purchase discounts are more likely to be offered by retailers while rebates are more likely to be offered by manufacturers such as automakers reduced interest rates by contrast lower the monthly payments on large purchases such as vehicles car shoppers are sometimes presented with a choice of a rebate or a reduced interest rate when purchasing a car the rebate option will give the buyer more immediate cash in hand but a lower interest rate can provide more significant savings in the long run rebates in securities tradinga short seller in the financial markets is betting that a stock or other asset will decline in price short sellers sell securities that they do not own in order to do that the trader must first borrow the stock from its owner and deliver it to the buyer when the trader places a short sale trade the stock must be delivered to the buyer on the trade settlement date the goal of selling short is to profit from a price decline in a stock by buying it at a lower price after the sale selling short exposes the seller to unlimited risk since the price of the shares that must be purchased can increase by an unlimited amount that said a trader can exit a short sale at any time to cap the risk if dividends are paid during the period that the stock is borrowed the borrower must pay the dividends to the lender similarly if bonds are sold short any interest paid on the borrowed bond must be forwarded to the lender 2 | |
when a short seller borrows shares the seller or the seller s broker might pay a rebate fee with interest to the lender of the shares | it is difficult for individual investors to qualify for a rebate as it requires holding a substantial sum in a trading account generally large institutions market makers and traders with broker dealer status are beneficiaries of rebates | |
when a short seller borrows shares to make delivery to the buyer the seller must pay a rebate fee this fee depends on the dollar amount of the sale and the availability of the shares in the marketplace if the shares are difficult or expensive to borrow the rebate fee will be higher | in some instances the brokerage firm will force the short seller to buy the securities in the market before the settlement date this is referred to as a forced buy in a brokerage firm may require a forced buy in if it believes that the shares might not be available on the settlement date 3before going short a trader should check with their broker what the short sale rebate fee is for that stock if the fee is too high it may not be worth shorting the stock the federal reserve board s regulation t requires that all short sale trades must be placed in a margin account a margin account requires the investor to deposit 150 of the value of the short sale trade 4 so for example if an investor s short sale totals 10 000 the required deposit is 15 000 since short sellers are exposed to unlimited losses a substantial deposit is required to protect the brokerage firm from potential losses in a customer s account if the price of the security increases the short seller will be asked to deposit more money to protect against larger losses if the price continues to rise on a position causing a larger loss and the borrower is unable to deposit more capital the short position will be liquidated the borrower is liable for all losses even if those losses are greater than the capital in the account 5for example assume a trader shorts 100 shares at 50 they are short 5 000 worth of stock and are therefore required to maintain a balance of 50 more than that or 7 500 if the stock drops there is no problem since the short seller is making money but if the stock rises rapidly the trader could face significant losses and may be required to put more money in the account if the stock jumps overnight to 80 per share and the trader is unable to get out before that it will cost them 8 000 to get out of that position the trader must increase the account capital to 12 000 to keep the trade open or exit the trade and take the loss if they take the loss it is 30 per share multiplied by 100 shares which is 3 000 this will be deducted from the 7 500 balance leaving them with only 4 500 minus fees example of a rebatesuppose a trader borrows 10 000 worth of stock abc with the intention of shorting it the trader has agreed to a 5 simple interest rate on the trade settlement date this means that the trader s account balance should be 10 500 by the time the trade is settled the trader is responsible for transferring 500 to the investor or the person they borrowed the shares from to make the trade on the trade settlement date | |
what is recapitalization | recapitalization is the process of restructuring a company s debt and equity mixture often to stabilize a company s capital structure the process mainly involves the exchange of one form of financing for another such as removing preferred shares from the company s capital structure and replacing them with bonds understanding recapitalizationrecapitalization is a strategy that a company can use to improve its financial stability or overhaul its financial structure to accomplish this the company must change its debt to equity d e ratio by adding more debt or more equity to its capital there are many reasons why a company may consider recapitalization including | |
when a company s debt decreases in proportion to its equity it has less leverage its earnings per share eps should decrease following the change but its shares would be incrementally less risky since the company has fewer debt obligations which require interest payments and return of principal upon maturity without the requirements of debt the company can return more of its profits and cash to shareholders | reasons to consider recapitalizationseveral factors motivate a company to recapitalize a company may decide to use it as a strategy to defend itself against a hostile takeover the target company s management may decide to issue more debt to make it less attractive to the potential acquirer another reason may be to reduce its financial obligations higher debt levels compared with equity means higher interest payments by trading in debt for equity the company can reduce the level of debt and therefore the amount of interest it pays to its creditors this in turn improves the company s overall financial well being furthermore recapitalization is a viable strategy to help keep share prices from dropping if a company finds that its shares are declining in value it may decide to swap equity for debt to push the stock price back up some companies may also use recapitalization to minimize their tax payments implement an exit strategy for venture capitalists or reorganize themselves during a bankruptcy companies often use this as a way to diversify their debt to equity ratio to improve liquidity types of recapitalizationcompanies can swap debt for equity or vice versa for many reasons an example of equity replacing debt in the capital structure is when a company issues stock to buy back debt securities increasing its proportion of equity capital compared with its debt capital this is called an equity recapitalization debt investors require routine payments and a return of principal upon maturity so a swap of debt for equity helps a company maintain its cash and use the cash generated from operations for business purposes reinvestment or capital returns to equity holders on the other hand a company may issue debt and use the cash to buy back shares or issue dividends effectively recapitalizing the company by increasing the proportion of debt in the capital structure another benefit of taking on more debt is that interest payments are tax deductible while dividends are not by paying interest on debt securities a company can decrease its tax bill and increase the amount of capital returned in total to both debt and equity investors governments may buy back shares to get a controlling interest in a company important to a nation s economy through nationalization another form of recapitalization governments also partake in the mass recapitalization of their countries banking sectors during times of financial crisis and when the solvency and liquidity of banks and the greater financial system come into question for example the u s government recapitalized the country s banking sector with various forms of equity to keep the banks and the financial system solvent and maintain liquidity through the troubled asset relief program tarp in 2008 1 | |
how does recapitalization work | a company can use recapitalization to improve its financial stability or overhaul its financial structure the company must change its debt to equity d e ratio by adding more debt or more equity to its capital | |
why would a company consider recapitalization | reasons include a drop in the business s share price to defend against a hostile takeover to reduce financial obligations and minimize taxes to provide venture capitalists with an exit strategy or bankruptcy | |
what forms does recapitalization take | companies can swap debt for equity or vice versa one version of equity replacing debt in the capital structure is equity recapitalization this is when a company issues stock to buy back debt securities increasing its proportion of equity capital compared with its debt capital one version of debt replacing equity in the capital structure is when a company issues debt and uses the cash to buy back shares or issue dividends the business thus recapitalizes by increasing the proportion of debt in the capital structure the bottom linerecapitalization is restructuring a business s debt and equity mixture the purpose is to stabilize a company s capital structure it mainly involves exchanging one financing form for another | |
what is a receipt | a receipt is a written acknowledgment that something of value has been transferred from one party to another in addition to the receipts consumers typically receive from vendors and service providers receipts are also issued in business to business dealings as well as stock market transactions for example the holder of a futures contract is generally given a delivery instrument which acts as a receipt in that it can be exchanged for the underlying asset when the futures contract expires | |
how a receipt works | receipts are used to document payments and business transactions companies and other entities use receipts to track their cash flows reimburse eligible payments or claim certain benefits on their taxes in some countries businesses are required to provide a receipt for each transaction each receipt should include the date of the transaction in most cases they include other details such as the nature of the transaction details of the vendor method of payment and any additional taxes or costs in some cases they may require a signature while receipts were once written out by hand today they are automatically generated at the point of sale types of receiptsin addition to showing ownership receipts are important for other reasons for instance many retailers insist that a customer must show a receipt to exchange or return items while others demand that a receipt generally issued within a certain timeframe be produced for product warranty purposes receipts can also be important for taxes because the irs requires documentation of certain expenses the internal revenue service irs suggests that the following types of receipts if generated be retained by small businesses origin of receiptsthe practice of retaining receipts for tax purposes is thought to originate from ancient egypt farmers and merchants sought ways to document transactions to avoid tax exploitation papyrus was used instead of paper in more modern times london banks used the printing presses of the industrial revolution to print receipts with their own brands thermal printing is the most commonly used form of physical receipt printing because it is low cost and easy to use today however paper receipts are increasingly giving way to electronic receipts in the form of emails or other digital record irs requirements for digital receiptsdigital receipts are becoming the norm since 1997 the irs has accepted scanned and digital receipts as valid records for tax purposes revenue procedure 97 22 states that digital receipts must be accurate easily stored preserved retrieved and reproduced the business owner must be able to supply a copy to the irs digital records are not subject to wear and tear as are physical receipts but they can be lost if a hard drive fails it s thus wise to store them on the cloud or somewhere where they can always be accessed paper receipts can be stored digitally using desktop scanners and mobile phone apps this type of technology can organize create expense reports and integrate data with bookkeeping software for tax audit purposes not all documentation is valid the irs accepts various documentation as long as it details the amount place date and type of expense | |
what are the types of receipts | common examples of receipts include packing slips cash register tape invoices credit card statements petty cash slips and invoices although the format for these forms may vary they all serve the same purpose of documenting the time and value of a business transaction | |
is an invoice the same as a receipt | an invoice is a request for payment while a receipt is a document for payment that has already occurred businesses frequently use invoices after providing a service to notify the customer of the expected payment | |
what are gross receipts | gross receipts are the total amount of cash or property that a business receives without accounting for any other expenses or deductions accountants use a company s gross receipts as one factor to calculate the firm s net income and profitability | |
what are read receipts | read receipts are used in emails to determine if a message has been opened or read by the recipient they are used in a similar way to mail delivery receipts as proof that a message has been delivered | |
how long should you keep receipts for taxes | for most expenses you should keep receipts and other records for three years after filing taxes as this is how long it takes for the period of limitations to run out however for some types of expenses such as unreported income or bad debt deductions the irs advises you to keep records for six or even seven years if you do not file a return or file a fraudulent return you should keep your records indefinitely 1the bottom linereceipts are one of the basic units of corporate accounting businesses use may use receipts as proof of payment to claim deductions on their taxes and to document expenditures on their income statements as well as to substantiate the existence of the assets on their balance sheets | |
what is the accounts receivables turnover ratio | the accounts receivables turnover ratio measures the number of times a company collects its average accounts receivable balance it is a quantification of a company s effectiveness in collecting outstanding balances from clients and managing its line of credit process an efficient company has a higher accounts receivable turnover ratio while an inefficient company has a lower ratio this metric is commonly used to compare companies within the same industry to gauge whether they are on par with their competitors investopedia zoe hansenunderstanding receivables turnover ratiosaccounts receivable are effectively interest free loans that are short term in nature and are extended by companies to their customers if a company generates a sale to a client it could extend terms of 30 or 60 days meaning the client has 30 to 60 days to pay for the product the receivables turnover ratio measures the efficiency with which a company is able to collect on its receivables or the credit it extends to customers the ratio also measures how many times a company s receivables are converted to cash in a certain period of time the receivables turnover ratio is calculated on an annual quarterly or monthly basis accounts receivables appear under the current assets section of a company s balance sheet formula and calculation of the receivables turnover ratiothe accounts receivable turnover ratio is the relationship between net credit sales and average accounts receivable 1wallstreetmojothe numerator of the accounts receivable turnover ratio is net credit sales the amount of revenue earned by a company paid via credit this figure does not include cash sales as cash sales do not incur accounts receivable activity net credit sales also incorporates sales discounts or returns from customers and is calculated as gross credit sales less these residual reductions it is important that the calculation uses a consistent timeframe therefore the net credit sales should only incorporate a specific period i e net credit sales for the second quarter only should returns happen in a future period this figure should be included in the calculation as it relates to the activity being analyzed the denominator of the accounts receivable turnover ratio is the average accounts receivable balance this is usually calculated as the average between a company s starting accounts receivable balance and ending accounts receivable balance companies with more complex accounting information systems may be able to easily extract its average accounts receivable balance at the end of each day the company may then take the average of these balances however it must be mindful of how day to day entries may change the average similar to calculating net credit sales the average accounts receivable balance should only cover a very specific time period high vs low receivables turnover ratioa high receivables turnover ratio can indicate that a company s collection of accounts receivable is efficient and that it has a high proportion of quality customers who pay their debts quickly a high receivables turnover ratio might also indicate that a company operates on a cash basis a high ratio can also suggest that a company is conservative when it comes to extending credit to its customers conservative credit policies can be beneficial since they may help companies avoid extending credit to customers who may not be able to pay on time on the other hand having too conservative a credit policy may drive away potential customers these customers may then do business with competitors who can offer and extend them the credit they need if a company loses clients or suffers slow growth it may be better off loosening its credit policy to improve sales even though it might lead to a lower accounts receivable turnover ratio a low receivables turnover ratio isn t a good thing that s because it may be due to an inadequate collection process bad credit policies or customers that are not financially viable or creditworthy a low turnover ratio typically implies that the company should reassess its credit policies to ensure the timely collection of its receivables however if a company with a low ratio improves its collection process it might lead to an influx of cash from collecting on old credit or receivables in some cases though low ratios aren t always bad for example if the company s distribution division is operating poorly it might be failing to deliver the correct goods to customers in a timely manner as a result customers might delay paying their receivables which would decrease the company s receivables turnover ratio the asset turnover ratio is another important metric it measures the value of a company s sales or revenues relative to the value of its assets and indicates how efficiently a company uses its assets to generate revenue a higher ratio means the company is more efficient a low asset turnover ratio indicates that the company is using its assets inefficiently to generate sales importance of receivables turnover ratiothe accounts receivable turnover ratio communicates a variety of useful information to a company the ratio tells a company usefulness of the accounts receivables turnover ratiolike other financial ratios the accounts receivable turnover ratio is most useful when compared across time periods or different companies for example a company may compare the receivables turnover ratios of companies that operate within the same industry in this example a company can better understand whether the processing of its credit sales are in line with competitors or whether they are lagging behind its competition | |
when making comparisons it s ideal to look at businesses that have similar business models once again the results can be skewed if there are glaring differences between the companies being compared that s because companies of different sizes often have very different capital structures which can greatly influence turnover calculations and the same is often true of companies in different industries | another example is to compare a single company s accounts receivable turnover ratio over time a company may track its accounts receivable turnover ratio every 30 days or at the end of each quarter in this manner a company can better understand how its collection plan is faring and whether it is improving in its collections limitations of the receivables turnover ratiothe receivables turnover ratio is just like any other metric that tries to gauge the efficiency of a business in that it comes with certain limitations that are important for any investor to consider some companies use total sales instead of net sales when calculating their turnover ratio this inaccuracy skews results as it makes a company s calculation look higher when evaluating an externally calculated ratio ensure you understand how the ratio was calculated another limitation is that accounts receivable varies dramatically throughout the year this is often the case with seasonal companies these entities likely have periods with high receivables along with a low turnover ratio and periods when the receivables are fewer and can be more easily managed and collected as such the beginning and ending values selected when calculating the average accounts receivable should be carefully chosen to accurately reflect the company s performance investors could take an average of accounts receivable from each month during a 12 month period to help smooth out any seasonal gaps example of receivables turnover ratiolet s say company a had the following financial results for the year we can calculate the receivables turnover ratio in the following way acr 64 000 72 000 2 68 000 artr 800 000 68 000 11 76 where acr average accounts receivable artr accounts receivable turnover ratio begin aligned text acr frac 64 000 72 000 2 68 000 text artr frac 800 000 68 000 11 76 textbf where text acr average accounts receivable text artr accounts receivable turnover ratio end aligned acr 2 64 000 72 000 68 000artr 68 000 800 000 11 76where acr average accounts receivableartr accounts receivable turnover ratio we can interpret the ratio to mean that company a collected its receivables 11 76 times on average that year in other words the company converted its receivables to cash 11 76 times that year a company could compare several years to ascertain whether 11 76 is an improvement or an indication of a slower collection process a company could also determine the average duration of accounts receivable or the number of days it takes to collect them during the year in our example above we would divide 365 by 11 76 to arrive at the average duration the average accounts receivable turnover in days would be 365 11 76 which is 31 04 days for company a customers on average take 31 days to pay their receivables if the company had a 30 day payment policy for its customers the average accounts receivable turnover shows that on average customers are paying one day late a company could improve its turnover ratio by making changes to its collection process a company could also offer its customers discounts for paying early companies need to know their receivables turnover since it is directly tied to how much cash they have available to pay their short term liabilities | |
what is a good accounts receivable turnover ratio | accounts receivable turnover ratio calculations will widely vary from industry to industry in addition larger companies may be more wiling to offer longer credit periods as it is less reliant on credit sales in general a higher accounts receivable turnover ratio is favorable and companies should strive to collect cash from customers as quickly as possible to lower the chances of money lost through non collection and to receive cash which can then be used to fund operations | |
should the accounts receivable turnover ratio be high or low | high accounts receivable turnover ratios are more favorable than low ratios because this signifies a company is converting accounts receivables to cash faster this allows for a company to have more cash quicker to strategically deploy for the use of its operations or growth 1 | |
what affects the accounts receivable turnover ratio | the accounts receivable turnover ratio is comprised of net credit sales and accounts receivable a company can improve its ratio calculation by being more conscious of who it offers credit sales to in addition to deploying internal resources towards the collection of outstanding debts | |
why is the accounts receivable turnover ratio important | the accounts receivable turnover ratio tells a company how efficiently its collection process is this is important because it directly correlates to how much cash a company may have on hand in addition to how much cash it may expect to receive in the short term by failing to monitor or manage its collection process a company may fail to receive payments or be inefficiently overseeing its cash management process the bottom linethe accounts receivable turnover ratio measures the number of times a company s accounts receivable balance is collected in a given period a high ratio means a company is doing better job at converting credit sales to cash however it is important to understand that factors influencing the ratio such as inconsistent accounts receivable balances may inadvertently impact the calculation of the ratio | |
what is a receivership | a receivership is a court appointed tool that can assist creditors in recovering funds in default and help troubled companies avoid bankruptcy having a receivership in place makes it easier for a lender to obtain the funds that are owed to them if a borrower defaults on a loan a receivership may also occur as a step in a company s restructuring process that s initiated to return a company to profitability it could arise as a result of a shareholder dispute over completing a project liquidating assets or selling a business dennis madamba investopedia | |
how receiverships work | a receivership is generally a process that s put into place to protect a company a period of receivership can be thought of as a protective umbrella for a troubled company a receiver or trustee steps in to manage the entire company its assets and all financial and operating decisions during this time the company s principals remain in place as material contributors while the receivership is operative but their authority is limited a receivership was traditionally intended to help creditors recover amounts outstanding under a secured loan if a borrower defaulted on its loan payments receiverships are one of the most powerful solutions available to aid creditors they re also used by companies in financial distress they can be part of a company s restructuring process a receivership can help when a company makes significant changes to its financial or operational structure typically while under financial duress a receivership can be used when a company is headed toward bankruptcy a receivership itself isn t a legal process but it s usually invoked during legal proceedings either the secured creditor lender or a court of law appoints a receiver to act as trustee of a business privately appointed receivers will generally act only on behalf of the secured creditor that appointed them court appointed receivers act on behalf of all creditors the receiver must be an independent party with no prior business relationship to either the borrower or the lender they can never act for the benefit of one party and to the detriment of another 1receivership and bankruptcy aren t the same but neither are they mutually exclusive they can occur at the same time or a receivership can occur without a company declaring bankruptcy responsibilities of a receiverthe appointed receiver generally has ultimate decision making power over the company s assets and management decisions in the case of a restructuring this includes the authority to stop paying dividends or applicable interest payments the receiver also ensures that all company operations comply with government standards and regulations while still maximizing profits the receiver customarily works with the company to help avoid bankruptcy a receiver may choose to shed select assets to pay some creditors and to bring the company into a period of recovery the court may order that a company s assets be liquidated if these efforts fail to achieve the purpose of the receivership or be seen as insufficient from the start a liquidator would oversee the sale of assets and collect the funds to repay creditors in this case the company would cease to exist when the assets are all sold bankruptcy vs receivership how are they different confusion over the terms bankruptcy and receivership is quite common but the fundamental differences are fairly straightforward bankruptcy is an action that s usually taken to protect a debtor from collection actions by creditors bankruptcy courts and rules are primarily aimed at shielding the borrower not the lender a company might file for chapter 11 bankruptcy when it wants time to solve its financial problems while maintaining business operations 2 it s generally for the purpose of liquidating and closing a business when a company files for chapter 7 bankruptcy 3there are other forms of bankruptcies but these two are the most common unlike bankruptcy a receivership isn t a legal action but rather an adjunct solution in the case of a secured lender a receivership is designed to protect the borrower s assets that represent the loan during an interim period until the creditor s claim is resolved by a court the secured lender asks the court to protect its security collateral land buildings business income or cash an independent party is put in charge of the assets and remains in possession and control of them until discharged by the court | |
what are some benefits of a receivership | there can be benefits for creditors as well as for a company creditors can be sure that the assets that secure the loans they made to a company remain protected and of value until their claims are handled a business can get a neutral objective professional to oversee problems that may concern management operations or financials the receiver can help position the company to thrive when the term of receivership ends who requests a receivership a secured creditor can request a receivership as a way to obtain funds or protect a borrower s assets until a court resolves the creditor s claim against the borrower | |
how long does a receivership last | receiverships can last anywhere from a few months to several years it depends on the reason why they re implemented a receivership put into place to help resolve the claim of one creditor could last less time than one that s used to remedy a company s ills so the company can avoid bankruptcy the bottom linereceivership is a court appointed remedy that may be used to assist creditors in recovering funds due to them when a company is unable to make payments on a loan it can keep a company out of bankruptcy as it restructures due to financial hardship but receivership is not bankruptcy it s considered a temporary phase of necessary oversight by a trustee until a company resolves claims against it by lenders and or regains its financial footing |
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