Like any industry, real estate has its own lingo that you won’t encounter in everyday life. But even if you’ve mastered all the terms associated with regular real estate purchases and sales, real estate investing has its own unique vocabulary to learn as well! So before you dive into the world of residential real estate investing, here are some key real estate investing terms to know:
When you sell any property, you’ll owe capital gains tax. But investors are able to defer the payment of this capital gains tax if they do a “1031 Exchange”. A 1031 Exchange allows an investor to essentially exchange one investment property for another. There is a specific process you are required to follow when doing a 1031 Exchange, but if you own an investment property and want to sell it and buy another investment property, it’s well worth your time to learn and follow the rules.
Capital Gains Tax:
Capital gains are the profit you make from the sale of an individual property. So capital gains tax is the tax that’s levied on those profits.
This term is fairly self-explanatory, but acquisition cost, as it relates to real estate investments, is the cost to acquire an investment property. But the acquisition cost is not merely the purchase price of the property. It also includes any additional fees and costs that are associated with assuming ownership of that property.
Just as in residential real estate, when a property appreciates, it increases in value. Appreciation can be caused by a number of things, but most notably by market changes and property improvements.
Net Operating Income (NOI):
The net operating income, or NOI, of a property is the expected annual income of the property minus the expenses and costs incurred for managing and owning it.
The capitalization rate, or cap rate, of a property is determined by taking the the net operating income (NOI) and dividing it by the property’s purchase price. But more simplyput, a cap rate helps you figure out what the ROI of your investment could be! It’s important to pay attention to cap rate because the higher the cap rate, the higher your return. The higher your return, the more opportunity you have to grow your wealth.
To calculate your cash-on-cash return, you will want to compare your annual pre-tax cash flow to the amount of cash you invested in the property to begin with. The higher your cash-on-cash return, the more profitable the investment is.
Equity is the difference between the property’s current market value and what you owe on the property. Equity is primarily influenced by market conditions and improvements made to the property.
Sometimes called CapEX, capital expenditures are any purchases or improvements that need to be made to extend the life of your property. Generally these are large, non-recurring expenses like replacing the roof or water heater. They are not things like interior/exterior paint or landscaping that need to frequently be redone. It is important to know how capital expenditures differ from your other expenses as they are handled differently during tax time.
Cash flow is defined as the amount of money you pocket at the end of the month after all expenses and costs for managing and owning the property have been taken care of. You should always aim for positive cash flow, meaning you earned more than you spent on your investment. And when evaluating future investments, always make sure you’re investing for positive cash flow from the beginning. Having consistent, recurring income from your investments is one of the most attractive aspects of being a residential real estate investor.
If you are going to invest with Equity & Help, owner financing is a very important term to know! When most people buy a property, they usually need some kind of financing to be able to afford such a large purchase. Typically this financing comes from the bank or a private lender. But at Equity & Help, the families that purchase the property borrow from and make payments to the owner of the property rather than the bank. We actually teach you how to become your own bank!
Bonus Term to Know: Philanthroinvestor®
You won’t find this term on the Bigger Pockets website or in any other real estate investment resource because this is a term we coined here at Equity & Help to describe our investor partners! Our investors are not only interested in growing their own wealth, they also want to help open the doors to homeownership to deserving families who otherwise would be unable to own a home of their own. Since we work with such a unique type of investor, we had to come up with a phrase to describe them and thus the term Real Estate “PhilanthroInvestor” was born!
If you have any additional questions on the terms listed above, real estate investing in general, or simply want to know more about how you can become a Real Estate PhilanthroInvestor with Equity & Help, give us a call at (844) 552-8828!