Amortization is the spreading of payments over multiple periods. In the case of real estate finance, those are typically monthly mortgage payments.
Amortization in lending
In lending, the term refers to a scheduled distribution of repayments into multiple cash flow installments. Two unique characteristics define a cash flow as amortization. The first is that each payment is for an equal amount. The second is that each payment blends both principal and interest. As time goes by, the balance shifts from interest to principal. Earlier payments will be almost entirely interest and later ones will be almost entirely principal.
Another use of the word has nothing to do with lending. It refers to the scheduled expensing of intangible assets’ acquisition costs — like those for software development or copyrights. Real estate is the most tangible of tangible assets of course, so investors in this space rarely use the term “amortization” this way. Buildings and other improvements to land are subject to depreciation, which is the same thing except for physical assets. (The land itself doesn’t depreciate.)
But even the real estate market isn’t totally unaffected by asset amortization. A real estate investment firm could have trademarks or patented business processes and, if another firm acquires it, this accounting concept could be applied.
More about amortization
A mortgage’s payment schedule is always an estimate. It usually assumes that borrowers will make their monthly payment precisely on time every month for 30 years — never early, never late. Of course, that rarely happens. A mortgage’s last payment, then, could be significantly different from all the previous ones. If more interest accrued than estimated, the borrower would need to make a balloon payment to pay in full.
Real estate transactions often involve mineral or water rights. In those cases, neither amortization nor depreciation applies. The correct term for allocating those costs over time is depletion.
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