The Top Real Estate Investing Terms

1. Gross Scheduled Income

Gross scheduled income is the annual income for the year. If there are vacant units, then simply add them to your calculations by its market rate. Remember, this income doesn’t include taxes.

formula for gross scheduled income

2. Gross Operating Income

Gross operating income is gross schedule income plus auxiliary income like laundry or any other services provided. We also subtract vacancy and credit loss to calculate gross operating income.

formula for gross operating income

3. Operating Expenses

Operating expenses are there to keep the property going and operational. These costs include insurance, maintenance, taxes, and general upkeep.

4. Net Operating Income

Net operating income is an important calculation because it helps determine valuation. So if you’re a real estate investor and are determining price, this calculation helps.

To calculate net operating income, take gross operating income and subtract it by the operating expenses.

 formula for net operating income

5. Cash Flow Before Tax

This calculation helps an investor determine what is left before tax.

Calculating cash flow before tax is done by taking gross operating income, and subtracting it to capital expenditures, and debt service. To make it simpler, we take gross operating income, and subtract it from all expenses.

formula for cash flow before tax

6. Gross Rent Multiplier

We first take the gross scheduled income to determine the rental income property’s market value. Then we determine the market value by looking at what other properties sold. Finally, we divide gross scheduled income from market value and find our gross rent multiplier.

formula for market value formula for gross rent multiplier

7. Cap Rate

If you remember any of these real estate investment terms, remember cap rate. Finding the best investment property from market values and income is hard to do. When incomes and market values all tend to stay in the same range, finding the best deal needs a more straightforward approach.

Cue cap rate.

Determining cap rate is found by taking net operating income and dividing it by market value. Another way we can determine market value is to divide net operating income by cap rate. Although cap rate is an important investment tool, make sure to look at different factors when determining investments. It’s also important to note that comparing similar properties when using cap rate makes cap rate more useful.

formula for cap rate

8. Cash On Cash Return

The cash on cash return is a ratio known to many real estate investors. It’s a ratio of cash flow before taxes and the amount of capital to make the acquisition.

formula for cash on cash return

9. Break-Even Ratio

The break-even ratio is a percentage to let investors and lenders know what percentage of income is expenses. Its usefulness also comes from helping investors know more about profitability. Another benefit is investors know when their initial capital is recovered.

formula for break even ratio

10. Loan To Value

Determines how much of the price or appraised value is financing. The higher loan to value means greater leverage which benefits the investor. But a higher loan to value is not good for the lender because it means a higher chance of default.

formula for loan to value

11. Operating Expense Ratio

Another one of the important real estate investment terms is operating expense ratio. Calculating is simple, all you have to do is take operating expenses and divide it by gross operating income.

formula for operating expense ratio

12. Debt Coverage Ratio

How much we cover debt with annual net operating income is debt coverage ratio. It helps investors know how much leeway there is before expenses start to take hold. A majority of those expense is the loan payment. Both principal and interest are included.

formula for debt coverage ratio

13. Mid-Month Convention

Another important real estate investment term to know is mid-month convention. This helps with depreciation. An example of this is when placing an asset in a given month, say October, the asset is assumed to have been put in place October 15th. This means we can only account for half the depreciation for the month.

14. Annual Depreciation Allowance

The allowance first depends on the depreciable basis. To calculate this, take the asset’s price and multiply it to the percent allotted to improvements. After, we take the depreciable basis and divide it by the useful life. The total will equal the annual depreciation allowance.

formula for depreciable basisformula for annual depreciation allowance

15. Taxable Income

Finding taxable income for real estate differs because there are different variables. We have to consider mortgage, depreciation, amortization, and more. But to get a sense on how to calculate taxable income, take net operating income and subtract operating expenses along with mortgage payments.

formula for taxable income

16. Time Value Of Money

Money right now is different from money in the future. This happens due to different factors. Some factors are inflation, and deflation, but having money right now compared to guaranteed money in the future is different because you have value right now. Taking into account when you receive money can be just as important as how much money you’re getting.

17. Cash Flow After Tax

Cash flow before tax takes into account all expenses. With cash flow after tax, we calculate tax liability and subtract it to cash flow before tax to find how much spendable cash we will have.

formula for cash flow after tax

18. Present Value

Present value is just the opposite of future value. You’re taking a future value and discounting it by a discount rate, or hurdle rate. This is useful when determining if a financial asset or liability proves worthy. For example, if we buy a machine for our business and calculate its future returns, will it still be valuable if we discount it back to today’s values? Another example is when we receive an ordinary annuity for the same amount for 10 straight years. If we discount all those amounts in the future by a specified rate, we can calculate how much it would total today.

19. Future Value

Two factors have to be assumed when calculating future value. The first is a constant growth rate, and the second is money untouched until a future date. An example of these two factors in context is this. Let’s pretend we have $10 right now. We then invest $10 at a constant growth rate of 10% for 10 years without touching it. Using either a table or calculator, our amount, assuming we haven’t touched the money is, $10 times 2.594= $25.94. Although it doesn’t seem like much, remember, we only put in $10. Retirement accounts or endowment funds put much more.

20. Net Present Value

Calculating net present value requires multiple steps. First, future cash flows have to be discounted back to present value using what’s either called the discount rate, or hurdle rate. Once that’s done, subtract it by the capital investment. This will get you your net present value.

Formula for net present value

21. Internal Rate Of Return

Even though I did a post on internal rate of return, it’s important to review it again. The internal rate of return is a discount rate that determines when the net present value of the investment is zero. It’s can be used for capital budgeting techniques, but since real estate investing uses cash flows, internal rate of return can also be used here.

22. Capital Gain

Capital gains happen when an asset’s value goes up. This can happen for stocks and real estate. But the gain is realized only when sold. And the other part investors hate are taxes. When selling an asset that experiences capital gains, taxes are put on those gains. This is another reason why investors love the buy and hold method.

23. Cash-Out Refinance

Investors looking for a down payment for other properties apply cash-out refinances. This means taking out new equity from the property and using the difference between the new equity and the old loan to get cash. There are multiple reasons people do this. One of them is to pay down debt, and another reason is to get some liquidity. But for investors, this cash is used to invest in other properties. There are drawbacks when refinancing though. This includes extra costs to pay. In addition, lenders may charge higher interest rates.

24. Homeowner’s Association  (HOA)

When an investor purchases property they become part of the Homeowner Association’s jurisdiction. The HOA can make and enforce rules for properties within its jurisdiction. If you’re an investor purchasing properties then you need to be a member of HOA as it is a requirement.

25. Homeowner’s Association Fee

It’s important to know this real estate investment term because you need to put it in your calculations. The purpose of this fee is to assist with maintaining and improving properties in the association. It’s usually paid monthly but the fee varies depending on the type of property the owner owns.

26. Triple Net Lease

This type of lease is used for commercial real estate such as office buildings, shopping malls, or industrial parks. A triple net lease makes a tenant responsible for insurance, maintenance or repair, and property taxes. The downside of having a triple net lease for an investor is the rent is lower than standard. On the other hand, it provides long-term stable income along with capital appreciation. Moreover, commercial property can roll over to 1031 tax-deferred exchanges meaning tax doesn’t have to be paid when an investor sells.

27. Closing Costs

Another real estate invest term that needs to be in your calculations are closing costs. These costs happen when the title of the property is transferred from seller to buyer. These costs are small, but they pile up if you don’t keep an eye out for it. Examples of closing costs are appraisals, application fees, inspection, origination fees for the creation of the loan by the bank, and private mortgage insurance for any down payments less than 20%.

28. Appraised Value

The value of an appraised home is determined by an appraisal company. They’re part of closing costs and it’s performed during the mortgage origination process. The bank or lender usually picks the appraiser and the main method for appraiser trying to valuate homes is to use “comps” or comparisons. For example, if a buyer is looking at a 3 bedroom 2 bathroom house and is looking for a price, the appraiser will look for a similar 3 bedroom 2 bathroom house to get a sense of houses with the same characteristics.

29. Warranty Deed

This is a document generally used to transfer property. This gives the person taking ownership of the property legal proof of ownership, and it also gives legal recourse against any claims against the property.

30. Recourse Loan

A recourse loan basically gives the lender the right to go after the borrower’s assets if the borrower doesn’t pay their financial dues. For example, if the borrower has a $100,000 loan and only repays $80,000 of it, the lender can go after any other assets the borrower owns, such as repossession of the real estate.

31. Credit Line

A credit line is a loan that is available after the original loan is paid off. When that happens, a new loan comes in which the investor doesn’t have to re-apply but they can also withdraw from.

There is a limit when withdrawing, and the only part that has to be repaid is the outstanding balance.

32. Due Diligence

Just like a good lawyer goes through every document and every detail, an investor goes through all the reports to verify the facts. It’s important to know what due diligence is when investing. Another example of due diligence is inspecting the property. Asking questions about property history, pipelines, foundation, HVAC system, and hiring a contractor to find details you don’t see is due diligence.

33. Fannie Mae

Known as the Federal National Mortgage Association; Fannie Mae buys mortgages and brings them together to sell them as securities. They are also known as contributors to the financial crisis of 2008.

34. Freddie Mac

Known as the Federal Home Loan Mortgage Corporation; Freddie Mac does what Fannie Mae does and buys securities to package them and sell them later as securities.

35. Lien

The right to possess a property by another owner until a debt is paid off.

36. Line Of Credit

A line of credit is a loan limited by time and money, but the line of credit doesn’t need to be re-applied for by the borrower.

37. Promissory Note

A promissory note is like an I.O.U. It’s an amount specified by terms and an amount.

38. Sale Leaseback

This is when a seller sells property and leases it right back at the same time, hence the name.

39. Section 8

Rental units in section 8 are part of a low income rental assistance program.

40. Seller Financing

One of the more creative tools for financing is seller financing. This financing happens when a seller can’t find a buyer and a buyer who can’t secure financing. Benefits of seller financing include cutting out the middle man saving money for both parties, and higher interest rates for the seller. But a negative is there’s not a 3rd party helping with negotiations.

41. Trust Deed

A trust deed is like a document stating that a 3rd party retains ownership of an asset but another party can use it for benefit.

As an example, imagine a title company holding the title of ownership on a real estate. This isn’t your real estate property yet because you got a promissory note to pay back to the lender. If the borrower doesn’t pay back the note, the title company fully owns the real estate.

42. Underwriting

Determining whether a loan should be approved based on quantitative and qualitative characteristics.

43. Unilateral Contract

In a unilateral contract, one party has to perform an act.  The only party under the contract is the party who has to transfer compensation for the act.

An example of this from a real estate perspective is getting a contractor under contract. Once the contractor does the specific job you want them to do, compensation is given. But the one under contract is the person transferring funds.

44. Usury

Lending money at a ridiculously high interest rate.

45. V.A. Loan

This home-mortgage loan applies only to veterans, service members, and not remarried spouses. They’re guaranteed by the U.S. Department of Veteran Affairs.

46. Adjustable-Rate Mortgage

The adjustable-rate mortgage also known as floating-rate or variable-rate mortgage varies interest rates throughout the life of the loan. The advantages of a adjustable-rate mortgage is the rate is fixed for 5-7 years. Meaning you pay the same amount for a long time before any adjustments happen. On the other hand, if rates fall while you’re in the fixed period, there is also the  option of refinancing for better rates.

47. Affidavit

A written statement that can be used as evidence in court.

48. Amortized Loan

When you pay off a amortized loan you pay off both principal and interest. Every time the interest is paid, the interest payment gets smaller. Inversely, as the interest payment gets smaller, the principal payment gets larger until the loan gets paid off.

49. Annual Percentage Rate

If you ever wonder how much it costs to borrow a loan, annual percentage rate calculates it for the year. But one factor to note is compunding isn’t part of the annual percentage rate so it won’t be the most up-to-date.

Factors that go into annual percentage rate are transaction fees, penalties, and interest-rate structure.

50. Balloon Loan

A balloon loan differs from other loans because you pay a large amount of the loan at the end of its life. It’s great for short-term borrowers because it carries a lower interest rate compared to long-term loans.

Monthly payments are set-up like a regular loan but then you pay off everything at the end.

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