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You can find plenty of jargon in every business, and real estate is no different. Unfortunately, it can throw you off for newbie investors, and understanding how the business works is a lot hazier. To help you get past this stage, we will break down the most common real estate investor vocabulary you need to know. If you’re entirely new to everything real estate-related, we recommend you check out our cheat sheet on the most common terms in all real estate.
Today’s focus will be exclusively to do with investing terms. So, this article is for you if you have no idea what a cap rate is or the difference between cash flow and NOR.
Cap RateCap Rate
Definition: Short for capitalization rate measures the annual rate of return on a property based on the profit it is expected to generate. The higher the number, the more profitable a place is. You can easily calculate it by dividing a property’s net operating income (NOI) by its purchase price.
It matters: Cap rate is one of several methods to analyze a property’s profitability. It’s the most helpful method because it lets you quickly compare different properties. It’s also a good indicator of a potential investment’s risk. 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: Net Operating Income – NOI measures 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 or income taxes.
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 considering 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. You have a negative cash flow if you’ve got more going out than coming in.
Why it matters: Regular monthly rent payments are one of the main reasons for investing in real estate. 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 investment amount. It tells you your return 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 helpful way to measure how good a return you get from what you’ve invested. However, since it doesn’t consider the total return on your investment (only the cash you’ve directly put in), it can give you a good idea of your leverage.
CapExCapEx
Definition: Capital expenditures, or CapEx, can be defined as any new improvements or renovations that increase the value of a property. This usually means something major, like a new roof, kitchen renovation, or plumbing redesign. It also includes the costs of any tools or services to carry out these improvements. On the other hand, something minor like a new paint job would not be covered.
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. When it comes to taxes, CapEx and regular maintenance are deducted differently.
1031 Exchange1031 Exchange
Definition: Real estate sales tend to come with hefty capital gains taxes, and section 1031 of the IRS code is your way to avoid paying some of them immediately. A 1031 Tax 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: The 1031 exchange can give you great flexibility when you’re looking to change some of your investments for those who primarily invest in single-family rental properties. The most successful investors know how to use this to their full advantage.
Gross Rental YieldGross Rental Yield
Definition: Gross Rental Yield is how much income a property generates after all purchasing expenses and closing costs have been paid. It’s what you have left over before you subtract maintenance, insurance, and other operating expenses.
Why it matters: It can give you a quick insight into how much of an annualized return you’re receiving on an investment.
AppreciationAppreciation
Definition: Real estate assets can increase in value over time, known as appreciation. Depreciation is the opposite when a property’s value goes down over time. It’s primarily driven by market fluctuations such as increasing demand, falling supply, and interest rate changes.
It matters: A property’s appreciation rate is vital in determining how worthwhile an investment it is.
EquityEquity
Definition: Equity measures how much of a property an investor owns than its market value. As you pay down your mortgage premium, your equity increases. You have left your equity if you sell and use the balance to pay off your mortgage.
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 ready to move into immediately.
Why it matters: Investors will want to find turnkey properties wherever they can, so they can immediately start renting them out. On the other hand, 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 sold for. If it’s positive, it can be realized after the property is sold. However, 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 crucial to 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 considers 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 lets you quickly compare your different investments to see which ones create the most outstanding returns.
Comparative Market AnalysisComparative Market Analysis
Definition: A CMA is a tool used by investors and real estate brokerages to estimate the market value at any time. Every investor and broker will have their methodology for doing a CMA. However, it’s usually based on similar properties sold recently and the general state of the market in a specific area.
Why it matters: CMAs help determine your offer price when buying an investment. You won’t want to pay more than a property is worth; a CMA can tell you whether a property is over or underpriced.
Loan-to-ValueLoan-to-Value
Definition: Investors use LTV to measure how much debt or leverage a property has compared to its market value. Most investors will aim for a conservative LTV of 75-80%.
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.
Why it matters: When deciding between multiple investments, a GRI forecast can estimate how much 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.