Real estate investing terms. They can sound like a lot of jargon when you’re just starting out as a property investor. Breaking into this industry can be intimidating, especially if you’re hearing complex terminology and acronyms tossed around for the first time. However, it’s important you understand and have a solid working knowledge of the basic real estate concepts and definitions related to buying, owning, and renting residential investment properties. The list below is a great way to get acquainted (or re-acquainted) with the most common real estate investing terms.
Real Estate Terms: Deciding to Buy
Appraisal: The value of a property determined by an independent survey conducted by a lender based on the property’s condition and comparable listings to validate the purchase price
Comparable and comparative market analysis: Part of the appraisal process that identifies recent sales of similar homes (comparable) close in proximity to estimate a more precise value for the property in question
Building classifications: A way of determining the value, risk, and profitability of investment property based on its market value
Class A Properties:
- The most in-demand properties in the best condition/location with the most appealing features
- Usually new (under 10 years old) and/or luxury housing
- Lowest cap rate, highest assessed value, lowest risk, high rents, low ROI and yield
Class B Properties:
- Second tier to Class A properties—they’re in demand and in good locations
- Buildings are a little older (10-25 years old), yet not in need of significant maintenance
- Lower cap rate, higher assessed value, low risk, moderate-high rent, moderate ROI and yield
Class C Properties:
- Properties in less desirable locations
- Over 25 years old in need of general renovation (appliances are likely original)
- high cap rate, lower assessed value, moderate risk, low-moderate rent, moderate ROI yield (after the renovation costs)
Class D Properties:
- Properties in more fringe or mediocre locations with poor construction
- Over 30 years old in need of significant rehabilitation or system replacements
- Highest cap rate, lowest assessed value, high risk, low rents, high ROI and yield
- These are typically in crime infested areas.
- Homes are over 50 years old and are in need of major renovations
- Potential high income on paper but unless you are a seasoned investor stay far away from these.
Class A and Class B assets in major markets are the lowest risk, which means lenders are more generous with better financing options, lower rates, better terms and amortization, and lower debt service coverage requirements. Class C and D assets are higher risk, so lenders are more conservative and typically give you fewer financing options, high rates, and less ideal terms. Essentially, the higher the property class, the more expensive and desirable the property, and the lower the return. The lower the property class, the less expensive and perhaps less desirable the property, which means higher risk as well as an opportunity for a higher return. For property investors just starting out, Class B and Class C properties are a good place to start to strike a solid balance between risk and return.
Acquisition cost: The total price, including all fees (mortgage, closing costs, inspection fees, etc.) required to purchase an investment property
Inspection contingency: A term in the purchase agreement that grants the buyer to conduct an inspection of the home through the hire of an independent inspector, receive an inspection report about the property’s condition and issues, and negotiate costs with the seller or terminate the purchase agreement based on the content in the report and get the deposit returned
Turnkey property: A property that does not require any repairs or renovations to rent out to tenants—it is updated to current market standards. Some Investors will fix and rent up these units and sell them to new investors.
Rehabilitation: The repairs that need to be completed on an investment property to make it tenant-ready or ready for resale at a higher value, which can range from minor work such as repainting or installing upgraded fixtures to large-scale renovations such as replacing a roof or gutting a kitchen; the investor should be notified of necessary repairs prior to purchase, and are typically listed in the inspection report
Loan-to-value ratio (LTV): Ratio lenders use to measure the amount of the loan compared to the value of the property and to determine overall risk
LTV = Mortgage amount ÷ appraised property value (or sale price)
Lenders prefer lower LTVs and incentivize higher down payments by offering lower interest rates. Buyers with lower LTVs are considered low risk. However, buyers with low net operating income (to be defined below) are considered high risk and are assigned a high LTV.
Dollars per square foot ($/SF): A way buyers can compare properties of different sizes to one another after factoring in acquisition costs, loan costs, and operational costs
Real Estate Terms: Buying & Carrying Debt
Adjustable-rate mortgage: A mortgage where the rate varies over the course of the loan based on the benchmark interest rate that fluctuates due to market conditions.
Balloon Mortgage: A mortgage that has a fixed often short-term low rate. Balance is due all at once. This is typically seen in fix and flip projects or those following the BRRR method.
Fixed-rate mortgage: A mortgage where the rate remains consistent over the life of the loan.
Amortization: When an owner pays off a portion of the principal and interest in different amounts each month, allowing the owner to build equity earlier in the repayment process
Escrow: A third-party financial account that temporarily holds the money a buyer will pay for a property until all negotiations and conditions are agreed upon between the buyer and seller; it is also used by the lender to make mortgage payments, taxes, and insurance on behalf of the buyer to show the funds are readily available
Interest: The cost for borrowing money for a mortgage, accrued at a rate set by the lender and paid off over the life of the loan in addition to the principal amount borrowed; investors can write off interest as a business expense on their tax returns
Proof of funds: A statement from a financial institution that the buyer has enough funds to proceed with an offer to the seller
Underwriting: Determining the eligibility of a borrower by applying formal qualitative and quantitative criteria
Real estate owned (REO): Property that was foreclosed and is now in possession of the bank that was the mortgage holder; investors can anticipate that the property may not be in the best of condition, but REO properties are usually sold below market value, they can be a more appealing purchase.
Short sale: A type of sales transaction where the property sells for less than what is owed on a mortgage and the lenders issue a formal letter consenting to release the lien for an amount less than what is owed
Real Estate Broker vs Real Estate Agent: A real estate broker is an independent professional with a license to help people both buy and sell property; a realtor is an individual who serves as an agent in real estate sales, who is also a member of the trade association National Association of Realtors—all realtors are real estate brokers, but not all real estate brokers are realtors
Real Estate Terms: Owning
Assessment: The act of determining the real estate value for tax purposes
Assessed value: The dollar value assigned to a property by a public assessor for tax purposes
Appreciation: The increase of a property’s value over time, and can be attributed to improvement, increased demand, inflation, and/or weakening supply
Depreciation: The decrease of a property’s value over time, partially attributed to wear and tear. On residential properties this is over the course of 27.5 years.
Property Management: Individuals or companies paid by a property owner/landlord to oversee the day-to-day operations of a rental property, oftentimes used by remote and local investors alike
Remote investing: A type of real estate investing in which the investors are located geographically distant from their investment property; unlike traditional real estate investing where owners want to be close to their properties so they can check up on them, have a relationship with their tenants, and conduct maintenance, remote investing allows owners to buy into markets where there are favorable returns (e.g. higher rents and/or lower ownership costs) that might not be available in their area of residence and have the properties managed by a property management company because of their status as an absentee landlord.
HOA fee: The fee a property owner pays to the organization that creates and enforces community policies if their investment property is located within a homeowners or condo association; the fee goes toward maintaining and improving properties within the association
Real Estate Terms: Assessing Finances
Carrying costs: Costs an investor must factor into the list of expenses when rehabilitating a property from the time it’s purchased until it’s sold
Equity: The difference between a property’s present market value and the outstanding mortgage amount; the more a buyer pays down the mortgage balance and the more the property appreciates over time, the more equity the owner has in the property
Return on investment (ROI): The measurement (as a percentage) of the net profit of an investment property relative to the property’s total acquisition cost; a higher ROI means a higher yield for an investor
ROI = total profit ÷ total cost
1031 Exchange: A tax process in which property owners can defer paying taxes on capital gains by reinvesting proceeds from an investment property into a similar investment.
Capital improvement (CAP X): Any permanent improvement to a rental property that add to its value and use (e.g. new appliances or amenities)
After repair value (ARV): The value of a property after a new owner makes repairs or improvements, which impacts what the investor will be able to collect as rent
Gross debt service: The total amount of money required to pay (aka service the debt of) the principal, interest, taxes, and sometimes utilities
Debt-to-income-ratio (DR, D:I): The ratio that compares total minimum monthly debt payments to gross monthly income; lenders use this to measure a buyer’s ability to manage the debt service each month
Net operating income (NOI): The annual income generated from a rental property, which includes rent and other income sources like laundry, parking, and storage, after property expenses (utility, insurance, property management, HOA/COA fees, landscaping, and maintenance/renovation/repair costs) have been deducted; NOI does not include mortgage payments, depreciation, amortization, and capital expenditures, and is calculated before taxes
NOI = Gross income from a rental property (minus any vacancy) - property expenses
Simply, NOI is the income an investor would make from a property if it were owned free of a mortgage.
Cash flow: Net income generated by a rental property after property expenses and loan payments costs have been subtracted; cash flow can be both negative or positive depending on the amount of money spent in a given month
Cash flow = NOI - debt service payments
Essentially, cash flow is the amount of money a landlord can pocket at the end of the month after paying all ownership and operational costs.
Cash on Cash Return (CoC): A pre-tax calculation that measures the percentage of return on the actual cash invested in a property, which experts say is a more accurate analysis of the investment’s performance
Cash on cash return = annual pre-tax cash flow ÷ total cash investment (down payment)
Capitalization rate (cap rate): A percentage calculated by dividing the anticipated NOI by the rental property’s sale price to determine the potential/expected return on an investment before factoring in the mortgage
Cap rate = NOI ÷ sale price (market value) OR assessed value
A low cap rate usually comes with a higher price point (desirable location/high demand, property is in good condition) which means your yield will be lower. However, you can collect higher rent. A high cap rate comes with a lower price point because the property is a riskier investment (less desirable location/low demand, property is in so-so condition). However, a lower purchase price means you can get a higher yield.
Debt coverage ratio (DCR) or debt service coverage ratio (DSCR): A ratio that compares the investment property’s ROI to its debt service (amount of money owed to the lender each month)
DCR = ROI ÷ debt payment
Lenders use this calculation to determine if you’ll be able to generate enough income to repay the loan.
Net yield: Measurement of earnings on your investment property after all expenses have been deducted annually
Gross rental yield: A calculation used to estimate the annualized return on an investment property
Gross rental yield = Gross income from a rental property ÷ acquisition cost
Principal reduction: The part of the mortgage payment that goes toward paying the money borrowed, not the interest
Capital expenses/expenditure (CapEx): An expense related to property ownership or maintenance paid the moment it’s required (e.g. insurance payments, plumbing visits, landscaping, window screen replacements, etc.); capital expenditures tend to be the one-time larger-ticket expenses, renovations/improvements (and the supplies to make them), and new purchases made to extend the life of or add value to a property paid with capital expense reserves
Capital expense reserves: Money set aside each year to cover large expenses that will occur in years to come (e.g. roof replacements, new appliances, HVAC system repairs, etc.) so it’s not as huge of a hit to your cash flow
Internal rate of return (IRR): A measure of investment property’s long-term profitability (i.e. performance) that considers annual cash flow and the change in equity over the lifetime of the investment; also defined as the point where the net value of the expenses equals the gross rental income to indicate when the property truly becomes profitable
Debt-to-equity ratio: A ratio used to measure the buyer’s ownership of an investment property and compares how much a buyer has invested to how much they owe—essentially how much of the property is owned by the buyer
Real Estate Terms: Renting
Vacancy rate: The percentage of unoccupied units (not generating income) in a rental property portfolio at any given time
Tenant Screening: The process of interviewing, conducting background and credit checks, calling references, and fully vetting applicants to find the best possible tenant
FRBO: An acronym that means a property is “for rent by owner”
Liability insurance: Atype of insurance policy that protects property owners against claims of negligence or action that results in bodily injury or property damage to another party
Rental property: Investment property from which an owner receives monthly payments from tenants for living there
Short Term Rental: A type of rental property only leased for a short period of time, usually for vacationers, that comes furnished; property owners commonly use online marketplace services like Airbnb and VBRO to find renters
Long-term rental: The traditional type of rental property where tenant sign a lease for a longer period of time (1+ years)
Rental income: Income generated from rent payments the tenants make to the landlord for living on the landlord’s property
Rental property calculator: Often used to evaluate if a property is a good investment prior to buying, a rental property calculator is an online tool that allows owners to plug in associated costs of their investment property to predict the ROI, cash flow, and IRR
Single-family home: A free-standing residential property not attached to any other residential or commercial properties
Multi-family home: A residential property designed to house many different tenants (or groups of tenants) in separate units within a single structure
Mixed-use building: A property zoned for both commercial and residential use (e.g. a multi-family home where the ground floor is a convenience store)
Leasing fee: The fee a property owner pays to a property manager when the property manager signs a tenant for the rental unit; when a tenant renews their lease, the property owner pays a re-leasing fee to the property manager
Vacancy Provision: A sum of money set aside to help cover expenses in the event a rental unit is vacant for a period of time (typically 12% of the rent to allow 6% to cover vacancy and 6% to cover maintenance)
Fair Housing Act (FHA): Federal law that prohibits real estate agents, landlords, sellers, lenders, and any other party that has influence in the decision-making process of buying, selling, renting, and financing of housing from discrimination against individuals in a protected class based on race, nationality, gender, religion, family status, and disability
The Importance of Understanding the Lingo
Property investing can come with a hefty price tag. But if you do it right, you can be making a good amount of passive income from rent while letting the property appreciate. That’s why it’s essential to understand the key terms of real estate investing. When you can navigate the market with confidence, you’ll be on track to excelling as an owner and investor.