Essential Real Estate Investment Terms to Know

In every business, some specific terms and abbreviations are used. The real estate industry has its own set of terms related to real estate investing. It might seem overwhelming if you’re new to real estate investing. While it is a bit challenging to know every single term, some common ones are important to understand.

Knowing this real estate investment terminology makes it easier for beginners in real estate investing. It helps you communicate effectively with other real estate professionals and work more efficiently. You will often come across these terms as you get into real estate transactions. This article will help you understand the essential real estate investing terms, whether you are new to real estate or just need to brush up on the terms.

Real Estate Investment Terms to Know

Numerical 

1. 1% Rule: In real estate, the 1% rule says that your monthly rent should be at least 1% of what you paid for the property. It helps ensure your investment makes money.
2. 2% Rule: The 2% rule states that a property’s monthly rent should be at least 2% of what you paid for it. This rule will help ensure your investment is profitable.
3. 1031 Exchange: The 1031 Exchange is a tax rule in the US that allows investors to swap one property for another similar one without paying taxes on the profit. This way, you can save money on taxes when you invest in real estate.

A

1. Acquisition Cost

This is the cost or expenses incurred to acquire the property. It includes mortgage, inspection fees, costs incurred while obtaining title insurance, charges from credit reports, and deed record fees.

2. Appraisal

Appraisal is a lender-determined value of a property. The lender conducts the property’s survey independently to gauge and authorize the conditions and market value. And when you apply for a bank loan to buy the property, the bank evaluates if they are lending you the right amount of money.

3. Adjustable-rate & fixed-rate mortgages

With an adjustable-rate mortgage, the interest rate can vary over five or ten years. It is considered risky for property owners who have rented out a unit for over a few years. This is because the rate can increase based on market conditions. Conversely, the interest does not change throughout the loan for fixed-rate mortgages.

4. Amortization

Amortization is the method of paying off the debt through scheduled installments. These EMIs are inclusive of principal and interest.

5. Assessed value

Based on the city or state tax you owe for the property you own, the assessed value is the tax worth. Only a public tax assessor determines it.

Assessed value refers to the annual estimation of a property’s worth. This rate is based on the tax district of the city or county. A municipal assessor determines it after s/he reviews the neighboring property values.

6. Appreciation & Depreciation

Appreciation refers to the increase in the value of your property over a period of time. In contrast, when the property value decreases, it is called depreciation.

B

1. Building Classification

Buildings are generally classified based on their age, assessed value, expected rental returns, and risk involved. 

• Class A properties have the highest assessed value, highest rent, lowest risk, are newly built, and are less than 10 years old. 
• Class B units are located in good neighborhoods, have a low risk, and are 10 to 25 years old. 
• Class C buildings are usually over 25 years old and have a lower assessed value. 
• Class D apartments are over 30 years old and are located in below-average suburbs with the lowest assessed value and highest risk.

If you are a new property investor, it is recommended that you purchase a Class A, B, or C property, as all of them have a lesser risk.

2. Bank-owned Property 

When someone can’t pay their mortgage and their house doesn’t sell at a foreclosure auction, the bank takes the property back. That house then becomes a bank-owned property.

3. BRRRR Method

The BRRRR method refers to buying, rehabbing, renting, refinancing, and repeating. This helps investors grow with a portfolio of rental properties quickly, even without having much initial cash.

C

1. Capitalization (Cap) Rate

The cap rate is the capitalization rate, which shows how much money an investment property makes compared to its cost. It helps measure risk in real estate. It’s useful for comparing different markets and properties for sale. However, one downside is that it doesn’t consider the method of financing.

The formula is: Cap Rate = Net Operating Income (NOI)/Purchase Price or Current Market Value by 100%

2. Cash Flow

Cash flow is the money you are left with after paying all the costs of running your rental property, including loan payments. It can be positive or negative. If your earnings from the property are more than what you have spent, you have positive cash flow. But spending more than you earn is a negative cash flow, which means you are losing money on your investment. Aiming for positive cash flow is important to ensure your investment is profitable.

3. Cash-on-cash Return

Cash-on-cash (COC) return is a way to determine how much money you make from your investment. It is the percentage of the profit you get each year compared to the total money you have spent on the investment. This helps you find how well your money works, considering how you financed the investment.

The formula is: Cash on Cash Return = Annual Pre-Tax Cash Flow/Total Cash Invested x 100%

4. Comparative Market Analysis

Comparative market analysis refers to the estimated value of your property. This research involves evaluating other units similar in size, age, location, style, and construction to your apartment. It enables you to quote a competitive price to the seller.  

D

1. Depreciation

Depreciation in real estate means saving money on taxes by spreading out the cost of buying and improving a property over time. For residential properties, the standard recovery period takes 27.5 years, representing the estimated useful life of the property.

2. Debt-to-equity Ratio

The debt-to-equity ratio shows the amount of a property’s loan compared to what the owner actually owns.

3. Debt-to-income Ratio

The debt-to-income ratio helps in handling your monthly debts. It compares how much money you pay for debts each month to how much money you make before taxes. Lenders use this to check if you can manage your monthly debt payments.

E

1. Escrow

It is a contractual agreement that involves the creation of a third-party account that holds the finances a buyer will pay to the seller. The property investor deposits periodic payments to this temporary account so that the lender/bank pays for the mortgage and insurance.

2. Equity

Equity is the part of your property that you fully own. It is the difference between how much your property is worth now and how much you still owe on your mortgage. As the mortgage balance reduces, your equity increases.

F

1. FHA Loan

An FHA loan is a mortgage from a bank or financial institution, and it is insured by the Federal Housing Administration (FHA). If you meet specific rules, you can use an FHA loan to buy a house or invest in a property. The good thing is that FHA loans have fewer requirements than conventional mortgages.

2. Financing

Financing in real estate investing means getting the funds you need to purchase a property. It also involves determining how much of the property’s cost comes from your capital.

3. Foreclosure

Foreclosure is a legal process for the mortgage lender to recover the amount a borrower owes when they have repeatedly missed paying their monthly mortgage. It involves the lender taking control of the property and selling it at a real estate auction.

G

1. Gross Rent Multiplier (GRM)

The gross rent multiplier shows how much a property’s value is compared to the money it makes in rent each year.

The formula is: GRM = Property Price/Annual Gross Rental Income

2. Gross Rental Income (GRI)

Gross rental income is the total money an investor makes from a rental property. It includes tenant rent, extra fees, and income from vending machines or other sources.

H

1. Housing Market

A housing market is all about the demand and supply of residential real estate properties available in a certain place, like a country, state, city, or neighborhood.

2. Homeowners Association (HOA)

A homeowners association is a private organization that manages the affairs and operations of real estate development, which is owned by multiple owners like an apartment building or condo. They establish and enforce rules everyone follows, and owners pay fees for the services provided by the association.

I

1. Interest

This refers to the rate the lender sets for the cost of borrowing money over a loan period.

2. Inflation

Inflation means prices for things increase over time. Real estate investing helps protect against inflation because real estate value tends to rise more than the general price increase over the long run.

L

1. Leverage

Leverage means using a loan to buy a real estate property. It is a benefit in real estate investing because investors can use someone else’s money to make money and build equity.

2. Long-term Rental

When you get a property to rent out for a long time, like monthly or yearly, it’s called a long-term rental. This is a common real estate investment strategy.

M

1. Mortgage

A mortgage is a secured loan from a bank or other financial institution to individuals. The bank keeps your new house as security until you repay the money. There are different types of home loans, each with its terms and durations.

2. Multi-family Home

A multi-family home, or property, is a building made for several families to live in different homes within it. Examples include duplexes, triplexes, quadruplexes, and apartment complexes.

N

1. Net Operating Income (NOI)

Net operating income is the money an investment property makes every year after deducting all the expenses related to the property. It may include property tax, management fees, and utilities. People use NOI in various calculations to find out how profitable a real estate investment is.

O

1. Occupancy Rate

The occupancy rate usually tells us how many units are being rented compared to the total number of units available. 

2. Open Listings

An open listing is an arrangement where multiple real estate agents can try to sell a property, and the owner can also advertise it for sale.

P

1. Price-to-rent Ratio

The price-to-rent ratio evaluates whether buying or renting a home in a certain area is better. To get this ratio, divide the average cost of a house by the yearly rental cost. If the ratio is low (15 or less), it suggests buying might be a good deal. A medium ratio (16-20) is average, while a high ratio (21 and up) may indicate that renting is a more economical choice.

2. Property Manager

A property manager is a company or an individual that helps landlords by handling their rental properties for a fee. Their responsibilities include deciding how much to charge for rent, dealing with tenants, communicating with property owners, looking after the property, paying bills, and more.

1. PropTech

PropTech, or property technology, includes all the tech tools that real estate investors, agents, brokers, developers, property managers, homeowners, and others in the housing and business property industries can use.

R

1. Refinance

In real estate, refinancing means swapping your existing mortgage with a new one either to make the payment period longer or to take advantage of a lower interest rate.

2. Rent Control

Rent control is legal regulations imposed by local governments on how much landlords can charge for rent in an area or how much they can raise rent over a period of time.

3. Rental Rate

The rental rate is how much a landlord or host charges tenants to stay in their place for a certain amount of time, like a day or a month.

4. Return on Investment (ROI)

Return on investment, or ROI, is a way that helps you find out how well your real estate investment is doing. It shows how much money you are making compared to how much you put into a property.

The formula for ROI is: ROI = Net Profit of Investment/Money Invested

S

1. Section 8 Housing

Section 8 housing is a federal government program that assists low-income families, senior citizens, and disabled people in getting affordable housing. It is funded and managed by the HUD, and to qualify, a household’s yearly income must be less than half of the median income for the area. In this program, households pay 30% of their income for rent and utilities, and the HUD covers the rest (70%). It is also known as the Housing Choice Voucher program.

T

1. Tenant Screening

This refers to the process of securing reliable tenants by conducting interviews, cross-checking credit and reference histories along with finding criminal records, if any.

2. Triplex

A triplex is a small building with three separate homes inside for different families to live in.

V

1. Vacancy rate

Vacancy rate is the percentage of the total number of your rental units that remain uninhabited for a period.

2. VA Loan

A VA loan is a special kind of home loan backed by the US government for veterans, current military members, and spouses of deceased military personnel. It offers better terms than conventional mortgages.

Bottom Line

All these are some basic terms you might encounter in real estate investing. It is important to understand these words, especially if you are new to investing in properties. There are more terms to learn as you go.

California’s real estate market shows no sign of slowing down. Property appreciation with lower mortgage rates is here to stay. So, start investing with the knowledge of the helpful terms explained above and consult Beach Front Property Management for much more.

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Tips on How to Invest in Real Estate for Beginners