Real Estate Investment Terms
Real estate terms to know for real estate investing world. Knowledge always build confidence, therefore make sure you know these basic terms before you talk to any real estate professionals. It’s not only make you sound smart, but also you can calculate your investment risk using some of these formulas.
CAP Rate (Capitalization Rate)
CAP rate shows potential return in your investment. One of the most important calculations that you have to do before you jump into any investment deal. It is basically your projected yearly gross income divided by the cost of the property.
Example: Cost of property = $ 350,000, expected monthly rent is $2,000/month.
CAP rate is (2,000 x 12)/350,000 = 6.85%
The bigger the CAP rate, the better the deal is.
Effective CAP Rate
Instead of projected yearly gross income, we use net yearly gross income. So you have to deduct any HOA fees, property taxes, insurance, vacancies, management fees, etc (any cost to maintain the rental property) to come to the net yearly income. Then use similar equation as above. Again, the bigger the rate, the better the deal is.
Net Cash Flow
As an investor, we always focus on cash flow. Cash flow is passive income for investors. It is gross income minus any mortgage payments and any rental related expenses. This number has to be positive. The bigger the number, the better the deal.
Cash on Cash Return
Most of the time, people get loan to obtain a property. It is another basic rule in investing, using OPM (Other People’s Money). With a loan, normally the buyer has to come up with a certain amount of down payment. This formula actually is your ROI (Return on Investment) for property that has mortgage loan. Mortgage payment consists of principal and interest. Principal payment is actually your “additional” income while interest is always an expense. You are creating more equity on the property each time a certain amount of principal is paid. So your cash on cash return will be (net cash flow+principal) / downpayment. The bigger the number, the faster you are earning back your original invested money, this means the better the deal is.
Residential Properties vs Commercial Properties
Any single condo, single town home, single family home,up to 4-plexes (1 building contains 4 units) is considered residential properties. Anything above 4 units is considered commercial properties.
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