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Six Real Estate Investing Terms for Beginner

PITI

Principal (P), Interest (I), property Taxes (T) and property Insurance (I). This is the minimum you need to calculate when thinking about purchasing an investment property with a loan. It is calculated overall and on a month-to-month basis.

GDS

Gross Debt Service Ratio is the percentage of gross annual income required to cover payments associated with housing. Payments include mortgage principal, interest, property taxes, property Insurance (PITI). The majority of lenders abide by a general standard of 32 per cent.

TDS

Total Debt Service Ratio is the percentage of gross annual income required to cover all debts monthly debts. Payments include mortgage principal, interest, property taxes, property Insurance (PITI), car payments, credit cards, alimony, and any loans. The industry standard for a TDS ratio (total debt service ratio) is 40 per cent.

Credit Report and Credit Score

Check your credit report and credit score to determine your ability to finance investment property. Most lenders today require 700 or better FICO (Fair Issac Co.) scores from borrowers who want to buy investment property. Also, make sure that your total debt-to-monthly-income ratio is low. Often it makes sense to pay down outstanding credit card debt or car loans in order to improve your debt ratios.

PCM

Poor cashflow management. Understanding all of the costs involved in acquiring and holding property can be difficult and you should always seek the advice of a mentor or professional accountant who knows about real estate investment to ensure you know exactly what you’re getting into financially. A good rule of thumb is to allow about 10% of the property’s value for costs such as rates, land taxes, insurance, maintenance and management fees.

Appraisal

<div dir=”ltr”>An appraisal is the evaluation of a property by a licensed appraiser on its price based on previous sales of similar properties.  The appraised value is used by a bank to determine the lending limit on a given property.</div>

Top 21 Real Estate Investing Terms

Gross Scheduled Income (GSI)

The annual rental income a property would generate if 100% of all space were rented and all rents collected. GSI does not regard vacancy or credit losses, and instead, would include a reasonable market rent for those units that might be vacant at the time of a real estate analysis.

Gross Operating Income (GOI)

This is gross scheduled income less vacancy and credit loss, plus income derived from other sources such as coin-operated laundry facilities. Consider GOI as the amount of rental income the real estate investor actually collects to service the rental property.

Operating Expenses

These include those costs associated with keeping a property operational and in service such as property taxes, insurance, utilities, and routine maintenance; but should not be mistaken to also include payments made for mortgages, capital expenditures or income taxes.

Net Operating Income (NOI)

This is a property’s income after being reduced by vacancy and credit loss and all operating expenses. NOI is one of the most important calculations to any real estate investment because it represents the income stream that subsequently determines the property’s market value – that is, the price a real estate investor is willing to pay for that income stream.

Cash Flow Before Tax (CFBT)

This is the number of dollars a property generates in a given year after all cash outflows are subtracted from cash inflows but in turn still subject to the real estate investor’s income tax liability.

Gross Rent Multiplier (GRM)

A simple method used by analysts to determine a rental income property’s market value based upon its gross scheduled income. You would first calculate the GRM using the market value at which other properties sold and then apply that GRM to determine the market value for your own property.

Cap Rate

This popular return expresses the ratio between a rental property’s value and its net operating income. The cap rate formula commonly serves two useful real estate investing purposes: To calculate a property’s cap rate, or by transposing the formula, to calculate a property’s reasonable estimate of value.

Cash on Cash Return (CoC)

The ratio between a property’s cash flow in a given year and the amount of initial capital investment required to make the acquisition (e.g., mortgage down payment and closing costs). Most investors usually look at cash-on-cash as it relates to cash flow before taxes during the first year of ownership.

Operating Expense Ratio

This expresses the ratio between an investment real estate’s total operating expenses dollar amount to its gross operating income dollar amount. It is expressed as a percentage.

Debt Coverage Ratio (DCR)

A ratio that expresses the number of times annual net operating income exceeds debt service (i.e., total loan payment, including both principal and interest).

Break-Even Ratio (BER)

A ratio some lenders calculate to gauge the proportion between the money going out to the money coming so they can estimate how vulnerable a property is to defaulting on its debt if rental income declines. BER reveals the percent of income consumed by the estimated expenses.

Loan to Value (LTV)

This measures what percentage of a property’s appraised value or selling price (whichever is less) is attributable to financing. A higher LTV benefits real estate investors with greater leverage, whereas lenders regard a higher LTV as a greater financial risk.

Depreciation (Cost Recovery)

The amount of tax deduction investment property owners may take each year until the entire depreciable asset is written off. To calculate, you must first determine the depreciable basis by computing the portion of the asset allotted to improvements (land is not depreciable), and then amortizing that amount over the asset’s useful life as specified in the tax code: 27.5 years for residential property, and 39.0 years for nonresidential.

Mid-Month Convention

This adjusts the depreciation allowance in whatever month the asset is placed into service and whatever month it is disposed. The current tax code only allows one-half of the depreciation normally allowed for these particular months. For instance, if you buy in January, you will only get to write off 11.5 months of depreciation for that first year of ownership.

Taxable Income

This is the amount of revenue produced by a rental on which the owner must pay Federal income tax. Once calculated, that amount is multiplied by the investor’s marginal tax rate (i.e., state and federal combined) to arrive at the owner’s tax liability.

Cash Flow After Tax (CFAT)

This is the amount of spendable cash that the real estate investor makes from the investment after satisfying all required tax obligations.

Time Value of Money

This is the underlying assumption that money, over time, will change value. It’s an important element in real estate investing because it could suggest that the timing of receipts from the investment might be more important than the amount received.

Present Value (PV)

This shows what a cash flow or series of cash flows available in the future is worth in today’s dollars. PV is calculated by “discounting” future cash flows back in time using a given discount rate.

Future Value (FV)

This shows what a cash flow or series of cash flows will be worth at a specified time in the future. FV is calculated by “compounding” the original principal sum forward in time at a given compound rate.

Net Present Value (NPV)

This shows the dollar amount difference between the present value of all future cash flows using a particular discount rate – your required rate of return – and the initial cash invested to purchase those cash flows.

Internal Rate of Return (IRR)

This popular model creates a single discount rate whereby all future cash flows can be discounted until they equal the investor’s initial cash investment. In other words, when a series of all future cash flows is discounted at IRR that present value amount will equal the actual cash investment amount.

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