Investing in real estate can be daunting if you don’t speak the language. Don’t worry! We’ve crafted this short guide to help you sound like a pro, calculate your Cash Flow, and maximize your ROI today
Turn-key Real Estate
A widely misused term across the industry. The only definition we accept is a property that has no deferred maintenance and is ready to start generating positive passive cash flow once you complete the purchase
Buying a property with deferred maintenance is equivalent to asking to be punched in the face repeatedly. Not everything has to be new, but the 20 year old furnace and rusty water heater are going to cause you (and your tenants) a lot of pain and suffering. Stock up on the Advil.
This term should make the hair on the back of your neck stand up. It runs the gamut between turn-key and ‘it’s better than living under a bridge.’ It’s best to ask follow-up questions.
This is an investor’s master spreadsheet for evaluating a property’s financials. It takes account of things like rental income, repairs, vacancy loss, management expenses, and carrying costs (mortgage payment, etc.). While reality sometimes differs from the estimate, if it looks bad on a Proforma, it’s going to be bad.
How much money you have to blow (or invest) at the end of each month. If you subtract of all of your monthly expenses (mortgage payment, management fees, property taxes, insurance, etc.) from rental income, you end up with your monthly cash flow.
Return on Investment (ROI)
This is what it all boils down to. The ROI is the measure of how well an investment is working for you. To figure it out, divide the net income (annual rents minus principal, interest, taxes, management fees, insurance, etc) by your actual cash outlay. For example, you put down $20,000 on a $100,000 that has a net cashflow of $3000 per year. Your ROI is $3000/$20000 = 15%. By the way, Warren Buffett says stock market investors should expect a long-term ROI of 6-7% per year after fees.
‘Cap’ is short for capitalization. In simple terms, the cap rate is equal to your yearly gross income divided by the cost of the property.
Effective Cap Rate
This is nearly the same as the cap rate, but with a healthy dose of reality. The effective cap rate takes your operating expenses (excluding any mortgage payment) into consideration. So, instead of dividing your gross income by the cost of the property, you divide your net income.
Loan to Value Ratio (LTV)
You’ll hear your lender throw this one around all the time. It refers to the ‘loan to value’ ratio of a particular mortgage. For example: If you owe $60,000 on a house that’s worth $100,000, then your LTV is 60%.
Capital Gains Tax
The mechanism by which the tax man dips his greedy little fingers into your real estate investment pie. If you sell a property for profit, you can expect Uncle Sam to get his share.
The tax man taketh and the tax man giveth. The IRS allows a deduction for depreciation of real estate and related capital expenditures. This is seldom included in a Proforma because the benefit depends on your tax bracket.
Self-Directed IRA – Your financial advisor will swear this is not allowed, but it is perfectly acceptable (and highly beneficial) to buy and hold real estate in a traditional or Roth IRA. You simply have to have a Self-Directed account upon which your financial advisor earns nothing hence, the objection.
Now that you know some of the lingo, you’re ready to dip your toe into the exciting waters of turnkey real estate investment. Let us know if you have any questions!