You can find plenty of jargon in every business, and real estate is no different. It can really throw you off for newbie investors and make understanding how the business works a lot hazier. To help you get past this stage, we’re going to break down the most common real estate investor lingo you need to know. If you’re completely new to everything real estate-related, then we recommend you also check out our cheat sheet on the most common terms in all of real estate.
Today’s focus will be exclusively to do with investing terms. So, if you have no idea what a cap rate is or the difference between cash flow and NOR, this article is for you.
Cap RateCap Rate
Definition: Short for capitalization rate, which is a measure of the annual rate of return on a property based on the profit it is expected to generate. You can easily calculate it by dividing a property’s net operating income (NOI) by its purchase price. The higher the number, the more profitable a place is.
Why it matters: Cap rate is one of several methods you can use to analyze how profitable property is. It’s by far the most useful method as it allows you to compare different properties easily. It’s also a good indicator of how risky a potential investment might be. While a high cap rate does mean a higher return, it also means a higher risk which must be considered.
Net Operating Income (NOI)Net Operating Income (NOI)
Definition: NOI is a measure of how profitable a potential investment may be. It can be calculated by dividing a property’s estimated annual revenue by its projected yearly operating costs. This only includes operating costs (maintenance, property taxes, HOA fees, etc.) and not mortgage payments.
Why it matters: NOI can be used to calculate a property’s cap rate. It’s also a good way to analyze different properties without thinking about financing.
Cash FlowCash Flow
Definition: Your net monthly profits after all operating expenses (including mortgage payments) have been deducted. A good investment is anything with a net positive cash flow. If you’ve got more going out than coming in, then you have a negative cash flow.
Why it matters: Regular monthly rent payments are one of the main reasons for getting involved in real estate investing. If you have a strong positive cash flow, you can use that money to cover maintenance costs, save for a down payment on a new property, or put it into a savings account.
Cash-on-Cash ReturnCash-on-Cash Return
Definition: Expressed as a percentage, this is a ratio of your annual pre-tax cash flow to the total amount of your investment. It tells you what your return is based on how much you’ve already put in. it does not include other benefits of property investment, like price appreciation and tax benefits.
Why it matters: Cash-on-cash is a useful way to measure how good of a return you’re getting from what you’ve invested. Since it doesn’t take account of the total return on your investment (only the cash that you’ve directly put in), it can give you a good idea of what your leverage is.
Definition: Capital expenditures, or CapEx, can be defined as any new improvements or renovations that increase the value of a property. It also includes the costs of any tools or services to carry out these improvements. This usually means something major, like a new roof, kitchen renovation, or plumbing redesign. Something minor like a new paint job would not be covered under this term.
Why it matters: CapEx are usually one-time projects that can cost a lot upfront but pay for themselves over time through price appreciation and extended lifecycles. Keep in mind that when it comes to taxes, CapEx and regular maintenance are deducted differently.
1031 Exchange1031 Exchange
Definition: Real estate sales tend to come with some hefty capital gains taxes, and section 1031 of the IRS code is your way to avoid paying some of them right away. A 1031 exchange allows you to defer paying some of these taxes so long as you put your profits from a sale towards a new investment of higher or equal value.
Why it matters: For those who primarily invest in single-family rental properties, the 1031 exchange can give you a great deal of flexibility when you’re looking to change some of your investments. The most successful investors know exactly how to use this to its full advantage.
Gross Rental YieldGross Rental Yield
Definition: GRY is how much income a property generates after all purchasing expenses, and closing costs have been paid. It’s what you have leftover before you subtract maintenance, insurance, and other operating costs.
Why it matters: It can give you a quick insight into how much of an annualized return you’re receiving on an investment.
Definition: Real estate assets can increase in value over time; this is known as appreciation. It’s largely driven by market fluctuations such as increasing demand and falling supply, as well as interest rate changes. Depreciation is the opposite and is when a property’s value goes down over time.
Why it matters: A property’s rate of appreciation is a vital component in determining how worthwhile investment is.
Definition: Equity is a measure of how much of a property an investor owns than its market value. As you pay down your mortgage premium, your equity increases. If you were to sell and use the balance to pay off your mortgage, what you have left is your equity.
Why it matters: Every investor seeks to build equity. With enough built, you can use it to take out a home equity loan which can be put towards renovations, college fees, or whatever else you desire.
Turnkey PropertyTurnkey Property
Definition: A turnkey property is any property that is ready to move into right away.
Why it matters: Investors will want to find turnkey properties wherever they can, as it means they can immediately start renting them out. Properties that need improvements and repairs before they’re ready to rent out are not turnkey properties.
Capital Gains TaxCapital Gains Tax
Definition: Capital gains are the difference between how much property is worth and what it is sold for. If it’s positive, then it can be realized after the property is sold. If it’s a short gain (made over less than a year), it is taxed at a higher rate than a long gain.
Why it matters: Knowing how your investments are taxed is a crucial part of any investment strategy. You’ll always want to increase your gains and avoid what taxes you can.
Internal Rate of ReturnInternal Rate of Return
Definition: IRR is a common term used in investor circles to measure a property’s long-term profitability. It takes into account both the annual net cash flow and an increase in equity over time.
Why it matters: Investors will want to pay close attention to IRR as it tells you how well your investment is doing. It also allows you to easily compare your different investments to see which ones create the greatest returns.
Comparative Market AnalysisComparative Market Analysis
Definition: A CMA is a tool used by investors and real estate brokerages to estimate the market value of a property at any one time. Every investor and broker will have their own methodology for doing a CMA. It’s usually based on similar properties that have sold recently and the general state of the market in a specific area.
Why it matters: CMAs are very useful for determining what your offer price should be when buying an investment. You won’t want to pay more than a property is worth, and a CMA can tell you whether a property is over or underpriced.
Definition: LTV is used by investors to measure how much debt or leverage a property has compared to its market value. Most investors will aim for a conservative LTV of no more than 75-80%.
Why it matters: Properties with an LTV of greater than 80% are considered over-leveraged and indicate a risk of negative cash flow due to a large loan payment.
Gross Rental IncomeGross Rental Income
Definition: GRI is how much money a landlord gains from a tenant through rent and other fees. Security deposits are not covered under this.
Why it matters: When you’re deciding between multiple investments, a GRI forecast can give you an estimate of how income a property could make. It should be followed by deductions to consider credit loss, vacancy, and other debts that can reduce your take-home pay.
Gross Rent MultiplierGross Rent Multiplier
Definition: GRM is a ratio of the price of a property compared to its GRI before expenses. It’s used to measure how long it takes for a property to make back the initial investment.
Why it matters: The lower your GRM, the better an investment tends to be. It’s a useful way to quickly compare the worth of different investments without going through an in-depth analysis.