Real Estate Investing Terms Every Beginner Should Know
There's no doubt about it: buying real estate can seem overwhelming at first glance! These are basic real estate terms you need to know in order to get started.
Real estate investing is an investment strategy that involves buying, selling, and renting properties. You can find great opportunities in both residential and commercial properties. While real estate investing can provide a steady stream of income for investors, it's important to understand the terms involved when investing in real estate.
At the heart of wise real estate investment is a thorough understanding of terms and key players.
Adopting a practical approach to real estate investing is the key to success. It's important for beginners to have an understanding of what terms and players are involved in the process. First, let's take a look at some of the most important terms that any beginner should know.
Rental Property: A rental property is any real estate that you rent out or lease to someone else. This could be your own home or an investment property you purchased with the intention of renting it out (a “buy-and-hold” strategy).
Short-Term Rental: If you only want to rent out your property for a period no longer than 3-12 months, then this is what you'll do with it! Short-term rentals provide more flexibility but also come with less income potential than long-term rentals do.
Long-Term Rental: Want to make sure your renters are around for good? Then consider going with long-term rentals instead! These typically yield higher returns over time because they involve greater commitment from both parties involved—you as owner/investor and them as tenant/renter—but also require more initial work on your part since there are many more details involved than in short-term rentals (such as securing financing).
Next up we have some key players...
Equity is the difference between the value of a property and the amount of debt against it. Equity is also known as net worth or net assets. Equity is calculated by subtracting the balance of all debts from the value of an asset. For example:
Joe owns a rental property that has an assessed value of $100,000 and has no mortgage on it (this means he's paid off his mortgage). The current market value for that house is $110,000.
His equity in this house would be $10,000 ($110k - $100k)
Rental income is the money you earn from renting out your property. Rental income is also called "net operating income" or "NOI." This is a key metric in real estate investing, as it represents your total monthly profit from renting out properties.
In addition to calculating rental income on a per-month basis, you can also calculate it on an annual basis. Simply divide the total amount of rent by 12 months (or 360 days) and you'll have your annualized rental income figure.
Cash flow is the difference between the amount of money you bring in from your rental property and the amount it costs you to run it. Some people refer to cash flow as "positive cash flow," since this means more money is going out than coming in. If a property has negative cash flow, that means there's more money going out than coming in—and that's not good for investment.
To calculate a property's cash flow, start by figuring out how much rent it generates each month—this is called gross operating income (GOI). Then deduct all expenses related to running the home: mortgage payments; property taxes; miscellaneous repair costs; insurance premiums; etc. The resulting figure indicates net operating income (NOI). For example: if your rental generates $2,500/month but costs $2,100/month to maintain and run, then its NOI would be -$400/month ($2,500 – $2,100 = -400).
If the NOI is positive (more income than expenses), then congratulations! That means your rental business has positive cash flow. However, if it has negative cash flow (-$400) then this might not be such good news...
A pre-approval letter is a document that a lender issues to a potential borrower, which states that the lender has reviewed the borrower's financial information and agrees to lend up to a certain amount to that borrower.
This document is used as proof of eligibility for financing when you make an offer on real estate.
A seller's market means fewer options of homes available and higher prices because there's more demand than supply in terms of listings and inventory.
When the number of homes on the market outweighs the number of buyers, it's a good time to be a buyer. Buyer's markets are generally considered favorable for buyers in that they allow them more options.
If there are more houses than people interested in buying them, sellers can expect to receive lower offers for their properties since there is less competition from other sellers. This means that you'll get more bang for your buck!
Appreciation is the increase in the value of a property.
It's important to remember that appreciation is not guaranteed, so don't get caught up in trying to time it perfectly.
The amount of appreciation may vary depending on location and other factors, but there are also periods when properties have no or negative appreciation (this happens most often during economic downturns). If you're investing for appreciation alone, be prepared for your investment to lose money from time to time!
Appreciation can take place over the course of months or years, so keep in mind that if you're looking for short-term returns on your investment, this isn't what you should be focusing on.
Predictive analytics is a method of forecasting future outcomes based on historical data. It is used to predict future sales, trends, and customer behavior. Predictive analytics also tries to spot patterns in the data that can be useful for making better decisions in real estate investing.
Hard Money Loan
A hard money loan is a type of real estate investment loan that gives you access to money in exchange for your property. The person who lends you the money owns the property and earns interest on it during its use as collateral. Most hard money lenders take possession of your home until they're paid back, so if you default on the loan, they'll foreclose on your house and sell it at auction to recoup their losses.
Hard money loans are typically used when conventional financing isn't available or affordable—for example, when buying distressed properties with cash flow problems (like a foreclosure), investing in a rental property without enough equity in it yet, or getting into a fixer-upper with big potential upside but little equity built up yet. A borrower has quite a bit more flexibility with this type of loan than he would with traditional financing: he can borrow an amount greater than his down payment; he can use 100% owner financing instead of having 25% down; he doesn't have to wait six months after closing before taking the title, and there aren't many restrictions about how long before purchase date funds need to be provided by either party (as opposed to standard mortgage rules).
Debt-to-Income Ratio (DTI) is the ratio of your monthly debt payments to your gross income. A low DTI means you'll be able to easily qualify for a home loan, while a high DTI means it will be difficult for you to obtain a loan.
A good rule of thumb is to keep the number below 36%, but there are exceptions depending on the type of property and location, so talk with your mortgage lender about what they would recommend for your situation.
Cash on Cash Return
The cash on cash return is a basic metric used to determine the relative value of a real estate investment. In simple terms, it's the percentage return you make on your investment after accounting for all costs (taxes, maintenance, etc.).
The formula for calculating cash on cash return is:
(Gross Rent - Operating Expenses) / Purchase Price = Cash On Cash Return
For example: If you buy an investment property for $100k and rent it out for $1,200/month at 7% cap rate, then your gross monthly rental income would be $1400 and operating expenses would be about $500 (6% of purchase price). Therefore your COCR would be 1.4%. In this case, we could say that with these numbers (and assuming no other fixed expenses), we'd expect our initial investment to compound by 14% per year over time.
Cap rate is the ratio of net operating income to the value of a property. In other words, it's used to determine how much money can be made on an investment property by dividing its net operating income (the amount left over after paying expenses) by its price.
Cap rates are useful ways to compare different properties and real estate investments because they don't take into account any additional factors like appreciation or depreciation. A higher cap rate means that you're getting more money back with each dollar invested, while a lower cap rate indicates that your investment isn't bringing in as much cash as others'.
For example: If you have two properties with similar prices but different monthly rents and expenses, one might have a higher cap rate than another because it has lower expenses (or vice versa). This could mean that even though one property costs more than another, it may actually be worth more when considering the overall profitability of investing in either property over time.
A credit score is a number between 300 and 850. It's based on your credit history, which includes any loans you have taken out or used in the past. Your credit history will affect the interest rate you get on loans. For example, if you have paid off a loan before its due date, that will improve your score. Credit scores also determine whether or not someone is a good risk to lend money to; they help lenders decide whether they should give out a loan at all.
Off-market properties are not listed on the MLS (Multiple Listing Service). Off-market properties are not advertised, and they're not listed on real estate websites.
In order to purchase an off-market property, you'll need a broker who knows what they're doing. Otherwise, you may find yourself buying a property that's overpriced or even completely worthless.
Internal Rate of Return
The internal rate of return (IRR) is the annualized rate of return on investment. It’s a measure of the profitability of a project or investment, calculated by discounting all future cash flows back to the present day at a single interest rate. It’s one way to compare different investments, and it can help you determine whether or not an investment is worth pursuing in the first place.
To calculate IRR, use this formula: (1 + IRR)/(1 – i) = 1/(1 + i), where i is the initial investment amount and IRR is your desired yield after taxes and fees are accounted for.
Real Estate Agent
A real estate agent is a professional who helps people buy, sell, or rent a property. They are also called "agents" or "brokers".
Real estate agents can be licensed by the state in which you live. They help their clients find properties that fit their needs and budget. Some real estate agents specialize in a certain type of property such as commercial or residential homes; others work with both types but have more specialized knowledge about one type than another (e.g., residential).
Real Estate Broker
A real estate broker often works for a brokerage firm or brokerage. These brokers have access to a database of properties for sale and can help you find the right home, negotiate the best deal and get into the property at an attractive price. They can also assist with paperwork, finding lenders, and even helping find a property manager.
Rental Property Calculator
There are many ways to determine how much rental property you can afford. One of the simplest methods is using a rental property calculator. This tool will help you figure out how much income your potential investment property can generate and how much it will cost to maintain and pay for other expenses.
Rental property calculators take into consideration several factors, including:
Gross Rent Multiplier (GRM): The GRM is an estimate of what the income from your rental property can cover in terms of mortgage payments, taxes, and insurance each month. For example, a GRM of 1.5 means that for every dollar in gross rents received by the landlord per month, he or she pays 50 cents toward mortgages and taxes on the building itself (and any other debt). A higher GRM means there's more money available after paying off those expenses; conversely, lower GRMs mean less surplus cash when all is said and done with paying off loans against real estate holdings.* Net Operating Income (NOI): NOI refers specifically to income from a single unit within a larger building—which may include apartments as well as retail stores or offices leased by commercial tenants—and does not include any leases signed by individual occupants within those units.* Capitalization Rate: The capitalization rate expresses what percentage return an investor would receive if he/she put down $1 million ($1M) into buying this particular piece of real estate today; this calculation takes into account both appreciation (how much more value could be added) as well as sinking funds needed over time because certain repairs need fixing again before resale becomes possible
Single-family homes are usually smaller than multi-family homes. They are also often cheaper than multi-family homes. The major difference between single-family and multifamily real estate is that single-family homes are owned by one family, whereas multifamily properties can be owned by several families.
Single-family homes tend to be more affordable for first-time investors because of their lower price tag compared to apartment buildings or condo complexes. However, there are also some disadvantages: For example, you’ll need additional skills when it comes to maintaining your property if you want to avoid costly repairs (e.g., repairing leaks in the roof). In addition, buying a home usually requires a down payment of 20%–30%.
A multi-family home is a house that has more than one unit. The units can be apartments, condos, or townhomes. Each of these individual units has its own kitchen, bathroom, and living space. This means that the property owner will have to maintain the property (including lawn care) as well as share utility costs for each unit.
When purchasing a multi-family home for investment purposes, it’s important for you to make sure that your tenants are credit-worthy and responsible people who will pay on time every month without fail. If you are looking into buying this type of real estate investment property then make sure you have a good inspection done first before making an offer so that there won’t be any surprises later down the line when buying something sight unseen online where pictures aren't always accurate, either due to lighting conditions or camera resolution limitations which may not show issues such as if there are cracks in walls, etc.
This is the real estate world, you need to know the terms and understand them. As a beginner, this list of basic real estate terms will get you started on your journey as an investor in no time!