Real Estate Concepts and Definitions For Buying, Owning, and Renting Residential Investment Properties EXPLAINED…
When you are hearing complex terminology and acronyms tossed around for the first It is important you understand and have a solid working knowledge of the lingo. The following gives you some real estate concepts and definitions related to buying, owning, and renting residential investment property….
Buying Property Terms
Appraisal
An appraisal is required to gather the estimated value of a piece of real estate. During the home sale, the mortgage lender sends out an appraiser to get a professional opinion of the value of the property. This helps the lender decide if the property is worth the amount of the loan the potential buyer is seeking.
Building Classification
Building classifications are a way to know the value, risk, and profitability of investment property”s market value…
- CLASS A – These properties represent the highest quality buildings in their market and area. They are generally newer properties built within the last 15 years with top amenities, high-income earning tenants, and low vacancy rates.
- CLASS B – These properties are one step down from Class A and are generally older, tend to have lower-income tenants, and may or may not be professionally managed. Rental income is typically lower than Class A, and there may be some deferred maintenance issues.
- CLASS C – These properties are typically more than 20 years old and located in less than desirable locations. These properties are generally in need of renovation, such as updating the building infrastructure to bring it up-to-date.
- CLASS D – These properties are in mediocre locations with poor construction and over 20 years old and in need of significant rehabilitation
The lower the property class, the less expensive and less desirable the property, which means higher risk as well as an opportunity for a higher return. For property investors just starting Class B and Class C properties are a good place to start to strike a solid balance between risk and return.
Acquisition cost
Refers to the all-in cost to purchase an asset. When acquiring property, acquisition costs can include surveying, closing fees, and paying off liens, inspection fees. mortgage etc.
Inspection contingency (also called a “due diligence contingency”)
Gives the buyer the right to have the home inspected within a specified time period, such as five to seven days. It protects the buyer, who can cancel the contract or negotiate repairs based on the findings of a professional home inspector.
A Turnkey Property
A property that does not require any repairs or renovation to rent out to tenants.
An LTV Ratio
Compares the amount of a loan you will borrow against the total value of the property you want to buy. Lenders generally use LTVs to determine how risky a loan is and whether they will approve or deny it.
Rehabilitation
The repair that needs to be completed on an investment property to make it tenant-ready. The investor should be notified of necessary repairs before purchase and are typically listed in the inspection report
Buying and Carrying Debt Terms
Adjustable-rate mortgage (ARM)
With ARM loans, interest rates can change after an initial fixed-rate period as they adjust based on the interest rate index the ARM is tied to (e.g., LIBOR, COFI, etc.). This loan type is less predictable than a traditional fixed-rate mortgage, but it can potentially yield lower interest rates during certain periods.
Fixed-rate Mortgage
With fixed-rate mortgages, your interest rate stays the same for the duration of the loan. They are often available as 10, 15, 20 & 30-year loans. The 15- and the 30-year loan is by far the most popular type of home loans, accounting for about 75% of all U.S. residential mortgages
Amortization
When an owner pays off a portion of the principal and interest in different amounts each month, allowing him to build equity earlier in the repayment process.
Escrow Holder
The escrow holder is the agent and depositary (impartial third-party) who collects the money, written instruments, documents, personal property, or other things of value to be held until the happening of specified events or the performance of described conditions, usually outlined in mutual, written instructions from the parties.
Interest
The cost of borrowing money for a mortgage, accrued at a rate set by the lender and paid off over the life of the loan. Businesses can use interest as a business expense on their taxes.
Proof of Funds
A statement from a financial institution that the buyer has enough funds to offer the seller.
Underwriting
Simply means that your lender verifies your income, assets, debt, and property details to issue final approval for your loan. An underwriter is a financial expert who takes a look at your finances and assesses how much risk a lender will take on if they decide to give you a loan.
Real Estate Owned (REO)
Real estate owned is a designation given to properties that are owned by a lender due to an unsuccessful foreclosure sale at auction. REO properties can sometimes present an opportunity for a buyer to be purchased for below market value as most banks would prefer to reinvest the proceeds, rather than waste time marketing the property for an extended period. Additionally, the bank will often market the property “as-is” meaning they are unwilling to make any repairs to the property, which can make financing tricky.
Short Sale
In a short sale, the property is being sold for less than the debt secured by the property. Short sales will require the approval of the seller’s lender(s) as the proceeds of the sale will be just “short” of the amount owed; most lenders’ processes of approving short sales are long and drawn out, requiring more time to close than a traditional sale.
Owning Terms
Assessment
The act of determining the real estate value for tax purposes
Assessed Value
The dollar value assigned to a property by a public assessor for tax purposes
Appreciation
When the value of the real estate increases over time because of an increase in demand for that property. As property becomes more scarce, but still desired, the price for it goes up.
Depreciation
The decrease of a property’s value over time, partially attributed to wear and tear.
Remote Investing
A simple real estate strategy that allows you to invest in strong markets across the U.S. This essentially means you own income properties within those markets and work with a partner or partners to oversee all the day-to-day management.
HOA Fee
Simply put, a homeowners association fee is money typically paid monthly by homeowners living within the HOA community to help maintain all properties, amenities, and common areas within the association.
Terms for Assessing Finances
Carrying Cost
A cost an investor must factor into the list of expenses when rehabilitating a property from the time it is purchased until it is sold.
Equity Home
Equity is the market value of a homeowner’s unencumbered interest in their real property, that is, the difference between the home’s fair market value and the outstanding balance of all liens on the property
Return on Investment (ROI)
The measurement is a percentage of the net profit of an investment property relative to the property’s total acquisition cost. A higher ROI means a higher yield for an investor.
Capital Improvement
A capital improvement is the addition of a permanent structural change or the restoration of some aspect of a property that will either enhance the property’s overall value, prolongs its useful life, or adapt it to new uses. Individuals, businesses, and cities can make capital improvements to the property they own.
Debt-to-Income Ratio
Debt-to-income, or DTI, ratio is a number used by mortgage lenders which is determined by the total of your debt expenses, plus your monthly housing payment, divided by your gross monthly income and multiplied by 100. This helps lenders determine affordability based on their available loan programs and allows them to estimate how much you can afford to pay monthly for a mortgage. Lenders typically look for borrowers who pay 28 percent, or less, of their total monthly income on housing, and less than 36 percent of their income on debt payments.
Cash Flow
Essentially, cash flow is the amount of money a landlord can pocket at the end of the month after paying all ownership and operation cost.
Cap Rate
Capitalization rate is a real estate valuation measure used to compare different real estate investments. Although there are many variations, a cap rate is often calculated as the ratio between the net operating income produced by an asset and current market value.
Debt Coverage Ratio (DCR)
Also known as Debt Service Coverage Ratio (DSCR), is a metric that looks at a property’s income compared to its debt obligations. Properties with a DSCR of more than 1 are considered profitable, while those with a DSCR of less than one are losing money.
Net Yield
Measurement of earnings on your investment property after all expenses have been deducted annually.
Principal Reduction
The part of the mortgage payment that goes toward paying the money borrowed, not the interest
Capital Expense Reserves
Refers to funds that are set aside for future capital expenditures or long-term capital investments in a property. To create a CapEx reserve, an amount of money, usually on a per square foot or per unit basis, is reserved monthly or annually.
Internal Rate of Return (IRR)
The internal rate of return (IRR) is a metric used in financial analysis to estimate the profitability of potential investments. IRR is a discount rate that makes the net present value (NPV) of all cash flows equal to zero in a discounted cash flow analysis. … It is the annual return that makes the NPV equal to zero
Debt to Equity Ratio
The debt-to-equity ratio is a financial ratio indicating the relative proportion of shareholders’ equity and debt used to finance a company’s assets. Closely related to leveraging, the ratio is also known as risk, gearing, or leverage.
Renting Terms
Vacancy Rate
The percentage of unoccupied units(not generating revenue) in a rental property portfolio at any given time
FRBO
An acronym that means a property is ” for rent by owner)
Liability Insurance
A part of the general insurance system of risk financing to protect the purchaser from the risks of liabilities imposed by lawsuits and similar claims and protects the insured if the purchaser is sued for claims that come within the coverage of the insurance policy.
Rental Property
Investment property from which an owner receives a monthly payment from tenants for living space.
Fair Housing Act
FHA prohibits discrimination because of race, color, national origin, religion, sex, familial status, and disability. … HUD’s Office of Fair Housing and Equal Opportunity (FHEO) works to eliminate housing discrimination and promote civil rights and economic opportunity through housing.
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