Real estate agents and investors just starting to become involved with real estate investing will typically discover very quickly that it’s a different world filled with lots of unrecognizable terms and concepts.
In time, of course, it tends to all make sense. But in the beginning at least, real estate investing can appear foreign enough to dumbfound most of us.
In this article we will look at some commonly-used concepts associated with real estate investing listed under five separate categories.
A. Cash Flow
- Gross Scheduled Income (GSI) – The annual rental income generated as if all units are 100% occupied
- Vacancy and Credit Loss – The annual rental income lost due to vacancies, nonpayment of rent, or the inability to place the property in service for any reason.
- Gross Operating Income (GOI) – The annual gross income available prior to any allowance for operating expenses: GSI – Vacancy and Credit Loss.
- Operating Expenses – The annual cost associated with keeping a rental property in service such as property taxes, insurance, utilities, management fees, and routine maintenance and repair.
- Net Operating Income (NOI) – The annual cash flow collected before debt, income taxes, and depreciation are considered: GOI – Operating Expenses.
- Debt Service – The annual amount paid to service the mortgage.
- Cash Flow Before Tax (CFBT) – The annual cash available before consideration for the owner’s income tax liability: NOI – Debt Service.
- Cash Flow After Tax (CFAT) – The spendable cash generated from the investment after consideration for the owner’s tax liability: CFBT – Taxes.
B. Returns, Ratios, Measures
- Capitalization Rate (Cap Rate) – One of the most popular real estate investing returns that represents the relationship between a property’s value and its net operating income: NOI / Value
- Gross Rent Multiplier (GRM) – A simple method used to estimate the market value of a property: Market Value / GSI = GRM and GRM x GSI = Market Value.
- Cash-on-Cash Return (CoC) – The ratio between the property’s cash flow before taxes and the initial cash invested to purchase the property: CFBT / Initial Cash Invested.
- Operating Expense Ratio – The ratio of a property’s operating expenses to its gross operating income: Operating Expenses / GOI.
- Debt Coverage Ratio (DCR) – The ratio between the property’s net operating income for the year and the annual debt service: NOI / Debt Service.
- Break-Even Ratio (BER) – A benchmark often used by lenders to estimate how vulnerable a property is to defaulting on its debt if rental income declines: (Debt Service + Operating Expenses) / Gross Operating Income.
- Loan-to-Value Ratio (LTV) – The ratio between the total amount of mortgage financing and the property’s appraised value or selling price, whichever is less: Loan Amount / Lesser of Appraised Value or Actual Selling Price.
- Internal Rate of Return (IRR) – By definition internal rate of return is the discount rate at which the present value of all future cash flows is exactly equal to the initial capital investment. Think of it as the rate of return an investor collects on the capital investment.
- Net Present Value (NPV) – This is the dollar amount difference between the cash investment and present worth of all future cash flows at a given discount rate (i.e., desired rate of return). An amount equal to or greater than zero means that return is met.
C. Income Taxes
- Depreciation (Cost Recovery) – The amount of tax deduction an owner may take each year until the entire “useful life” of the depreciable asset is written off as specified in the tax code. It applies to the physical improvements only (not the land). The useful life for residential property is 27.5 years and 39 years for non-residential property.
- Tax Shelter – The allowable deductions an owner may take each year for depreciation, amortized loan points, and mortgage interest.
D. Time Value of Money
- Present Value (PV) – What a future cash flow or series of cash flows is worth in today’s dollars. The mathematical procedure is discounting. That is, future cash flow is discounted at some rate to determine its present value.
- Future Value (FV) – The sum that a cash flow or series of cash flows will be worth at a specified time in the future. The mathematical procedure is compounding. That is, cash flow is compounded at some rate to determine its future value.
- APOD – The Annual Property Operating Data (APOD) provides a quick evaluation of the rental property’s financial performance before taxes for the first year of ownership.
- Proforma Income Statement – This provides a forecast of the rental property’s financial performance over some number of years.
- Marketing Package – A presentation of the financial and other data associated with an income property used when selling the property.
So You Know
ProAPOD provides real estate investing software solutions that automatically compute for everything listed in this article.