As a new property investor, it’s easy to feel intimidated and a bit confused when you encounter terms you don’t recognize. However, learning a few basic terms can help you make smart real estate investment choices.
The good news is that most of these terms are relatively easy to understand. Some contain borrowed concepts that you might have learned from a business or finance class. In addition, learning is a never-ending curve, so you gain bits of knowledge as you continue investing in real estate.
We’ve listed some common real estate terms you are likely to encounter. These terms will help you to communicate effectively with real estate professionals and to understand the key terms when it comes to real estate investing.
Net Operating Income (NOI)
Net Operating Income (NOI) refers to a property’s potential to be profitable. It's an important metric used by investors to make informed investment decisions.
NOI is calculated by subtracting all expenses pertaining to the different revenue streams from the investment.
Examples of expenses include: maintenance, property taxes, management fees, maintenance, and repairs. Revenue streams include: rental income, parking fees, laundry, and vending machines.
Cash Flow
Cash flow is defined as the amount of money that flows within an investment and can either be positive or negative.
Positive cash flow includes all the money that moves into the investment such as rental income. Contrarily, negative cash flow refers to the expenses attached to an investment.
Cash flow is also used to determine whether an investment is making a profit or experiencing losses. If your investment is experiencing losses, you may consider raising the rent, but that may cost you your current tenants.
Instead, consider other ways of increasing your cash flow without increasing the rent.
Cash-on-Cash Return
Cash-on-cash return is the ratio of annual pre-tax cash flow that is accounted to the capital of the investment.
Expressed as a percentage, cash-on-cash return is used to measure the yearly return in relation to capital.
Cash-on-cash return does not take into consideration other benefits of property ownership such as depreciation, tax benefits, and loan pay down. However, calculations based on standard ROI take into account the total return on the investment.
Basically, cash-on-cash return measures the return on the actual cash invested. It is the amount of money left within the current period (which is typically one year).
Gross Rental Yield
Gross rental yield is the total income that is generated from a property divided by the amount of money spent in purchasing the property and associated closing costs. It is typically expressed as a percentage of the investment price.
In the calculation of gross rental yield, operating expenses such as property taxes and management fees are not taken into account.
Appreciation
Appreciation basically refers to the increase in value of an asset over time.
Appreciation occurs as a result of a number of reasons such as increased demand, decreased supply, and inflation and interest rate fluctuations.
Depreciation
Depreciation is the opposite of appreciation and refers to the decrease in value of an asset over time.
Given that market demand and other forces negatively affect property, depreciation can occur in any property market. Understanding depreciatation is essential for investing in real estate.
Adjustable Rate Mortgage (ARM)
An adjustable rate mortgage (ARM) is a type of mortgage that does not have a fixed interest rate. Based on the benchmark interest rate that is impacted by the capital market, an ARM can change monthly throughout the life of the loan.
The initial interest rate is usually affixed in the beginning of the investment but changes after a number of year or according to the terms agreed upon.
Fixed Rate Mortgage
A fixed mortgage is a type of mortgage that has a predefined interest rate for the entire period of the loan. The monthly payment for a fixed rate mortgage is the amount required to be paid monthly by the tenant to completely clear the loan with interest by the end of the mortgage term.
Equity
Equity refers to the difference between the current market value of the property and the amount of money the investor has taken as mortgage.
The amount of money that is contributed toward the purchase of a property or to make capital for the property is also referred to as equity.
Capital Gains
Capital gain or loss is the difference in the value of a property compared to its purchase price.
If there is an addition to the amount of money invested once the property is sold, then it is called a gain. Contrarily, if the money realized after sale of the property is less that the amount invested, it is then referred to as a loss.
A short-term capital gain is realized within one year or less whereas a long-term gain is one realized in more than a year. Both must be claimed on your income taxes, but short-term capital gains have a higher tax rate than long-term capital gains.
Either option has different tax benefits, so always check which option is best for yourself and your property.
Debt-to-Equity Ratio
The debt-to-equity ratio is loosely defined as a measure of ownership. This ratio is used to determine how much of the property you own. This is especially true if you have taken mortgage on your property.
It is also used to determine the amount in which one is indebted.
Internal Rate of Return (IRR)
Internal Rate of Return (IRR) is one of the common terms that you will encounter in real estate. IRR is a discount rate that makes the future income streams of the property equal to the initial capital investment/purchase price.
Taking into account the annual net cash flow and the change in equity over time, IRR is the measure of a property’s long-term profitability.
Bottom Line
There’s no use in feeling overwhelmed by the new jargon and terminologies when you can rely on the reputable services of the premier property management company, Schambs Property Management.
We provide exceptional services to cover all your rental property's needs! If you’re looking for a professional property manager to help you invest wisely and care for your properties, look no further than Schambs Property Management.