5 Terms You Must Know as a Real Estate Investor
When you first get into the world of real estate investing, you’re going to hear a lot of new lingo. Some of it you may understand already, but there are other terms that will likelyleave you scratching your head. Still, it’s important that you understand these unfamiliar concepts, because they each play an important part of your overall investment experience.
Here are 5 terms that you absolutely must know as a real estate investor:
- Cash flow - This is arguably one of the most important pieces you need to know. Basically, it’s how much money you have left over each month after all your expenses have been paid. To find it, take the cash income you’re making off a property, subtract all the cash expenses associated with it (mortgage, utilities, repairs, etc.), and the figure you’re left with is your cash flow.
- Net operating income - Usually known as NOI, this term refers to how much income a property will generate. Income usually is in the form of rent payments, but can be generated in other ways as well, such as laundry fees, pet fees, and other add-ons. To determine NOI, an investor subtracts their operating expenses from their operating income. But wait, this sounds a lot like how cash flow is calculated, right? Yep, but the key difference is that cash flow deals with cash alone, while NOI takes into account non-cash factors, like depreciation and deferred maintenance. Consequently, NOI gives you a much more accurate measure of an asset’s profitability.
- Cap rate - Short for capitalization rate, cap rate is an estimation of the rate of return an investor can expect to get on a property. It’s expressed as a percentage, and it’s found by dividing the NOI by the property’s current market value. This is an important calculation to make as it gives you another look at a property’s profit potential. For instance, if you’re thinking of buying a property valued at $100,000, and you calculate the NOI to be $10,000 per year, then the cap rate is 10%. You know you’re getting a return of 10% of your property’s value each year. This is a good figure to know so you can quickly and easily compare different properties.
- Leverage - This one isn’t a calculation like the ones I have included above, but it’s still an important one to know, and seems to be one that confuses some people even though it’s a fairly common term. Simply put, leveraging is using another person or entity’s money to increase your own profits. If you take out a mortgage to buy a new property, you don’t own the property in full. You own a percentage (which depends on how much you put down), and the bank owns a percentage. However, you are still able to use the full value of the property. You have a relatively small financial input, but you’re still reaping all the rewards of ownership.
- Exit strategy - With every real estate investment you make, you must have an exit strategy in mind. In other words, you have to have a plan for selling the property once you’ve finished with it. This may not occur for a very long time; it could be years away, or it could be months. It really depends on your overall strategy and how the property in question impacts it. Regardless, you need a gameplan for unloading it when the time comes. Some of your options include working with a real estate agent and listing the property on the MLS, selling it by owner, selling it to another investor, selling it to a wholesaler, or selling it to your tenants using a rent-to-own method.
Learning the lingo is just part of the package deal when you start investing, and there’s a lot to learn. These are just 5 of the concepts you should familiarize yourself with, and believe me when I say there are many more. My advice would be to get online and do a search for real estate investing terms, and then just start absorbing what you read. If you find a great list of terms and their meanings, print it out and keep it on your desk for easy reference. Again, the goal is to familiarize yourself with this information so that it becomes a part of your regular vocabulary and you understand it inside out.