Term: Cap Rate

Definition: Capitalization rate, or cap rate for short, is used to measure the annual rate of return on a real estate investment based on the profit that property is expected to generate. Simply put, it’s the ratio between the net operating income (NOI) and purchase price. Cap rate is calculated by dividing net operating income (NOI) in the first year by the property purchase price. (NOI excludes loan costs if you use financing).

Example: Say you purchase a property for $150,000.
The expected NOI in the first year is $12,000.
$12,000/$150,000 = 0.08 Cap rate: 8% Why it matters: Cap rate is one piece of the puzzle to include when evaluating an investment property. Lower-yielding properties tend to be safer investments, while higher-yielding homes typically come with a little more risk. Both types of properties potentially have a place in your rental portfolio—it’s just a matter of why you’re investing in rental income properties and what you hope to achieve.

Term: Net Operating Income

Definition: Net operating income (NOI) is a measure of a real estate investment property’s potential to be profitable. It’s calculated by estimating the property’s revenue and subtracting all operating expenses such as repairs, maintenance, property taxes, HOA fees, etc. NOI does not include mortgage payments. Why it matters: NOI allows you to analyze properties of all different types without looking at financing terms. NOI is also required to calculate cap rate.

Term: Cash Flow

Definition: Cash flow is the amount of money you can pocket at the end of each month, after all operating expenses (including loan payments) have been paid. If you spend less money than you earn, your cash flow will be positive. If you spend more money than you earn, your cash flow will be negative.

Rental income - all operating expenses (including loan payments) = Cash flow
Why it matters: Consistent monthly rental income is one of the most appealing reasons to invest in real estate. Ideally, an investment property should be cash-flow positive. This means rent is higher than the monthly mortgage, which provides a steady stream of passive income. This passive income can go toward maintenance expenses, the down payment on another investment property, or a savings account.

Term: Cash-on-Cash Return

Definition: Cash flow is the amount of money you can pocket at the end of each month, after all operating expenses (including loan payments) have been paid. If you spend less money than you earn, your cash flow will be positive. If you spend more money than you earn, your cash flow will be negative.
Rental income - all operating expenses (including loan payments) = Cash flow
Why it matters: Consistent monthly rental income is one of the most appealing reasons to invest in real estate. Ideally, an investment property should be cash-flow positive. This means rent is higher than the monthly mortgage, which provides a steady stream of passive income. This passive income can go toward maintenance expenses, the down payment on another investment property, or a savings account.

Term: CapEx

Definition: CapEx, or Capital Expenditures, are defined as new purchases or major improvements/renovations that extend the life of a property, such as replacing a roof, adding an extension or finishing the basement. This term also covers equipment and supplies required to make these improvements. Generally these are one-time, major expenses.
Why it matters: Most parts of a house will eventually need replacing. Though the big-ticket items may only be needed every 20 years, it’s important to know there will come a time where you have to pay $1,200 to replace a bathroom floor, or $4,500-$10,000 to replace the roof. Just remember—these repairs/improvements ultimately extend the overall life and value of your investment property.

Term: HOA fees

Definition: A homeowner’s association is an organization that creates and enforces rules for the properties located in a subdivision, community or condominium. Purchasing property within an HOA’s jurisdiction means you automatically become a member and are required to pay monthly HOA fees to assist with maintaining and improving properties within the association.
Why it matters: When evaluating rental investment properties for purchase, it’s important to know if there will be HOA fees since these cut into cash flow and may need to be factored into your rental rates. Be sure to ask what the HOA fees cover and how they compare to other HOA fees in the area.

Term: Gross Rental Yield

Definition: Gross rental yield is the total income generated by a property, divided by the price paid for the property and associated closing costs. This is what you get before deducting operating costs (maintenance, property management, insurance, HOA fees, etc). Why it matters: Gross rental yield provides investors with a quick reference for an annualized return on an investment. Monthly rent x 12 / purchase price and associated closing costs = Gross yield

Term: Appreciation

Definition: Appreciation is an increase in the value of an asset over time.
The increase can occur for a number of reasons, including increased demand or weakening supply, or as a result inflation or interest rate fluctuations. This is the opposite of depreciation, which is a decrease in the value of an asset over time. Why it matters: Like a property’s cap rate, appreciation is an important piece of the puzzle when evaluating the overall appeal of an investment property. As the market value of your rental increases, so does ROI.

Term: Adjustable Rate Mortgage (ARM)

Definition: An adjustable rate mortgage (ARM) is a mortgage that does not have a fixed interest rate. Rather, an ARM can change monthly throughout the life of the loan based on the benchmark interest rate, which fluctuates based on capital market conditions. The initial interest rate is typically fixed for the first few years and then resets periodically
Why it matters: As an investor, you need to know what your potential risks are. With an ARM, your monthly mortgage payments could increase or decrease depending on market conditions.

Term: Fixed-Rate Mortgage

Definition: A fixed-rate mortgage is a mortgage loan that has a predefined interest rate for the entire term of the loan that never changes. The monthly payment for a fixed-rate mortgage is the amount that needs to be paid by the borrower every month to ensure the loan is paid off in full with interest at the end of its term.
Why it matters: Fixed-rate mortgages are appealing because monthly mortgage payments stay the same, which makes budgeting and planning for future investments a little easier.

Term: Equity

Definition: Equity is the difference between the current market value of the property and the amount that you (the owner) owe on the property’s mortgage. If you were to sell your investment property, the equity would be the money you receive after paying off the mortgage in full. This value can build up over time as the mortgage balance declines and the market value of the property appreciates.
Why it matters: Building home equity is a great strategy for building long-term wealth. At some point you’ll want to tap into your home equity, whether it’s to fund your retirement, upgrade to a different home, help pay for a major life event.

Term: Turnkey Property

Definition: A turnkey property is a home or apartment that is completely, or very close to move-in ready.
Why it matters: Turnkey properties are appealing from an investment standpoint since investors can purchase a property and rent it out immediately without making any major repairs. Even if there are some improvements that need to be made at some point, investors can start earning rental income right away.

Term: Capital Gains Tax

Definition: Capital gain or loss is the difference in the value of a property compared to its purchase price. If there is a gain, it is realized after the asset is sold. A short-term capital gain is one year or less; a long-term gain is more than a year. Both must be claimed on your income taxes, but short-term capital gains have a higher tax rate than long-term capital gains.
Why it matters: Understanding how your real estate investments are taxed is important if you’re looking to optimize performance and returns.

Term: Debt-to-Equity Ratio

Definition: In real estate, debt-to-equity (D/E) ratio is a measure of ownership. This ratio helps you determine how much of your property is actually yours (if you took out a mortgage to finance it) and how much you owe in debt.
Why it matters: This is important because it paints a more holistic picture of your investment. It tells you how much capital you have invested and how much you owe, which gives you a rough idea of how much you’ll walk away with when you decide to sell. It also matters if you’re looking to refinance your investment property or borrow against it with a home equity line of credit, as lenders will consider your debt-to-equity ratio as a measure of creditworthiness.

Term: Escrow

Definition: Escrow is when an impartial third party holds on to something of value during a transaction. When you make an offer on a property, you will pay a portion of the down payment ahead of time. This payment will be held by an impartial third party in a separate bank account until the contract has been negotiated and the deal has been closed.
Why it matters: Escrow helps remove risk from transactions for both parties. The escrow agent holds the money exchanged in a purchase until all agreed upon conditions between the buyer and seller are met. Once these are completed, escrow funds are released to the seller.

Term: Closing Costs

Definition: Closing costs are the fees paid at the end of a real estate transaction. These fees vary depending on where you live, the property you buy, and the type of loan you choose. There are costs associated with inspections, transfer of title, loan origination fees, etc.
Why it matters: It’s important to budget accordingly for your closing fees so you have enough cash on hand at the time of purchase. Home buyers will typically pay between 2%-5% of the purchase price of the home in closing fees.

Term: Internal Rate of Return (IRR)

Definition: This is a common real estate investment term you’ll see when browsing rental properties or crowdfunding websites. The internal rate of return (IRR) is a measurement of a property’s long-term profitability that takes into account the annual net cash flow and the change in equity over time.
Why it matters: IRR is the single best estimate of your asset’s performance over the entire time that you plan to hold it. It allows you to evaluate investments that may have different cash flows or appreciation potential.

Term: MLS

Definition: The Multiple Listing Service (MLS) is a private offer of cooperation and compensation by listing brokers to other real estate brokers, according to the National Association of Realtors.
Why it matters: Only licensed real estate agents who are members of their local and national real estate association may list property on the MLS.

Term: FSBO

Definition: For Sale by Owner (FSBO) is a term used to describe a real estate owner that is selling his or her property without using a real estate agent or listing the property on the MLS.
Why it matters: Buying a FSBO property may offer a good opportunity for a buyer if part of the real estate sales commission the seller is saving is passed through to the buyer.

Term: CMA

Definition: Comparative Market Analysis (CMA) is a report that shows active and sold listings, listings taken off of the market, and listings that expired without being sold during a specific time period and in a specific neighborhood or geographic area.
Why it matters: Sellers use a CMA to help determine asking price and fair market value, market demand by reviewing the number of days it takes other similar listings to sell, and how motivated buyers are by analyzing the ratio between the listing price and the sales price. Buyers benefit from the same information on a CMA, and also by looking for property that has been taken off of the market and then relisted.

Term: CMA

Definition: Comparative Market Analysis (CMA) is a report that shows active and sold listings, listings taken off of the market, and listings that expired without being sold during a specific time period and in a specific neighborhood or geographic area.
Why it matters: Sellers use a CMA to help determine asking price and fair market value, market demand by reviewing the number of days it takes other similar listings to sell, and how motivated buyers are by analyzing the ratio between the listing price and the sales price. Buyers benefit from the same information on a CMA, and also by looking for property that has been taken off of the market and then relisted.

Term: PITI

Definition: PITI is an acronym for a mortgage payment that includes Principal, Interest, (Real Estate) Taxes, and Insurance. The monthly payment of most residential mortgages is PITI.
Example: $1,000 / month principal and interest payment + $40 / month homeowner’s insurance + $200 / month property taxes = $1,240 PITI per month
Why it matters: PITI has a significant effect on your total monthly cash flow, in addition to normal operating expenses. Sometimes real estate investors only calculate the monthly mortgage payment based on loan interest, but forget about the additional expenses of property tax and insurance on the house. When this happens, cash flow is overstated along with the profit potential of the rental property. Other extra monthly costs to add to the PITI include any mortgage insurance premium (MIP) and the monthly HOA fee if the property is in a homeowners association.

Term: FMV

Definition: Fair Market Value (FMV) is the reasonable price that a property would sell for on the open market when both buyer and seller are reasonably knowledgeable, free of undue pressure to complete the transaction, and are behaving in their own individual best interest. So, FMV should reflect an accurate valuation of value or worth at a specific point in time.
Why it matters: Knowing what the FMV of a property is helps a buyer understand if they are paying the right price for a property, and a seller understands if they are leaving money on the table. There are several ways for an investor to determine the FMV of real estate including a third-party appraiser, a CMA done by a real estate agent, and a BPO (broker price opinion).

Term: LTV

Definition: Loan-to-Value (LTV) is a percentage that measures the total debt or leverage on a property compared to the market value. In most cases, real estate investors will use a conservative LTV of no more than 75% to 80%. A property with an LTV greater than 80% can be described as being over leveraged, creating the risk of potential negative cash flow due to a larger mortgage payment.
Example: LTV = $75,000 loan / $100,000 market value = 75% LTV
Why it matters: In general, the lower the LTV is the less risk there is of having negative cash flow from a rental property. A low mortgage payment gives an investor the opportunity to set more net cash aside for capital repairs or a period of extended vacancy if the property takes longer to rent than anticipated. A conservative LTV also minimizes the risk of an investor having negative equity – sometimes described as being “upside down” - in the property during a downward real estate cycle where market values decrease but the loan amount stays the same.

Term: FHA

Definition: Federal Housing Administration (FHA) is a government agency that insures FHA mortgage loans. FHA loans are popular with first time home buyers because they allow for low down payments of 3.5% and low credit scores of around 580, or even lower credit score if a slightly higher down payment is made.
Why it matters: The FHA doesn’t make loans directly. Instead, borrowers can obtain an FHA loan from an FHA approved lender. In exchange for the more lenient lending requirements of an FHA mortgage, a borrower must pay a mortgage insurance premium (MIP) to protect the lender in case the borrower defaults. FHA loans are easier to qualify for because they require lower down payments and are less strict with credit score requirements.

Term: GRI

Definition: Gross Rental Income (GRI) is the amount of money collected in rent plus any additional income such as application fees, pet fees, parking fees, advance rent, or any expenses paid by the tenant to the landlord that are not required as part of the lease. Security deposits paid by the tenant are not considered to be income. Instead, refundable deposits are treated as a short-term liability on the balance sheet for the rental property because the deposit will eventually be returned to the tenant.
Why it matters: GRI is used by real estate investors to forecast the total amount of income a rental property could generate. When creating a property pro forma, investors begin with the GRI then make deductions for vacancy, credit loss, and bad debt to help determine how much adjusted gross income the investment will generate before paying the mortgage and normal operating expenses.

Term: SFH

Definition: Single-family Home (SFH) is the most common type of rental property for real estate investors. An SFH is a free-standing house that is different from a townhome or apartment because it does not share walls or utilities with a neighboring property, and is located on its own parcel of land.
Why it matters: GRI is used by real estate investors to forecast the total amount of income a rental property could generate. When creating a property pro forma, investors begin with the GRI then make deductions for vacancy, credit loss, and bad debt to help determine how much adjusted gross income the investment will generate before paying the mortgage and normal operating expenses.

Term: GRM

Definition: Gross Rent Multiplier (GRM) is the ratio of the price of a rental property to its gross rental income before expenses. Another way of thinking about GRM is that the ratio represents how many years it would take for an investment to pay for itself based on the gross rental income received. Everything else being equal, the lower the GRM is the better the investment may be.

Example:

● Market value / Gross rental income = GRM

● $100,000 market value / $12,000 gross rental income = 8.33

Why it matters: GRM is a quick way of ranking potential rental property investments before spending time on a deeper analysis. Unlike Cap Rate, which measures the rate of annual return based on net income (excluding mortgage expense), the GRM is a multiplier that uses gross income. Investors buying and selling real estate can also use GRM to estimate property value. For example, if the GRM for similar rental properties in the market is 7.5 and the property generates a gross annual rental income of $15,000 then the property value should be $112,500 (GRM of 7.5 x gross annual rental income of $15,000). Or, if a single-family house has an asking price of $100,000 and the market GRM for comparable property is 8.3, the gross annual income from the home should be $12,048 ($100,000 market value / 8.3 GRM).

Term: PMI

Definition: Private Mortgage Insurance (PMI) is an extra insurance charged by lenders to borrowers making a down payment of less than 20%. PMI protects or insures the lenders in the event a borrower defaults, and usually costs between 0.5% and 1.0% of the total loan amount.

Example: $100,000 loan amount x 1.0% PMI fee = $1,000 per year or $83.33 per month in addition to principal, interest, taxes, and homeowner insurance:

Why it matters: Borrowers who use an LTV higher than 80% are considered by lenders to be riskier than borrowers who can afford to make a bigger down payment. PMI is usually paid monthly, as part of the total PITI mortgage payment made to the lender. Once the loan balance reaches 78% LTV – in other words, when accrued equity in the property reaches 22% - a lender must terminate the PMI. If this doesn’t happen automatically, a borrower can contact their lender and ask for the PMI portion of the mortgage payment to be removed.

Term: REO

Definition: Real Estate Owned (REO) is property owned by the bank or lender that has already been foreclosed on but hasn’t been sold at auction. Many banks have REO departments whose job it is to get the property off of the bank’s balance sheet by selling it through a real estate agent who specializes in REO listings or through online platforms operated by FHA or HUD.

Why it matters: REO property can provide investors with a good opportunity to purchase a house at below market value. However, real estate owned property is sold by the lender “as-is, where-is” with only the most basic of warranties and no guarantees. REO houses are often in poor condition and may require a lot of repair work before they can be rented and generate cash flow. To increase the odds of getting an offer on a REO property accepted, investors should make strong offers with few or no contingencies and a large earnest money deposit to show the bank that they are serious about buying the REO home.

Term: CRE

Definition: Commercial Real Estate (CRE) is income-producing property that falls into the main categories of land, industrial, retail, office, special use (such as a gas station or government building), and larger multifamily apartment buildings. By contrast, Residential Real Estate includes property such as single-family homes, townhomes, condominiums and co-ops, and smaller multifamily property with two to four units.

Why it matters: Both commercial and residential property can generate cash flow and potential appreciation in market value to investors. However, unlike single-family houses, commercial property is more complicated to own and manage, more expensive to finance, and sometimes more difficult to sell.