A Lexicon is the vocabulary of a particular language or profession. The following list of terms defines each term in the way it is most commonly used in the field of real estate and investing.
Appreciation is the increase in value of a property over time due to inflation, supply and demand, capital improvements and other factors.
A rate of return on a real estate investment property based on the expected income that the property will generate. Capitalization rate is used to estimate the investor’s potential return on his or her investment. This is done by dividing the income the property will generate (after fixed and variable costs) by the total value of the property.Capitalization Rate (cap rate) = Yearly income (after expenses) / Total Value
The profit that an owner makes when selling real estate or other property.
The difference (in monetary value) between the total amount spent (expenses) and the total amount received (income) in a given period (e.g., monthly, yearly).
Cash on Cash Return
Debt Coverage Ratio
Also known as Debt Service Coverage Ratio (DSCR). The debt coverage ratio (DCR) is a widely used benchmark which measures an income producing property’s ability to cover the monthly mortgage payments.
Depreciation is the loss in value of an asset / building over time due to wear and tear, physical deterioration and age.
When property is sold at a gain, some element of that gain is attributable to depreciation deductions taken in prior years.
Discounted Cash Flows
A valuation method used to estimate the return of an investment opportunity. Discounted cash flow (DCF) analysis uses future free cash flow projections and discounts them (most often using the weighted average cost of capital) to arrive at a present value, which is used to evaluate the potential for investment. If the value arrived at through DCF analysis is higher than the current cost of the investment, the opportunity may be a good one.Calculated as:
The value of a property owner’s unencumbered interest in real estate. Equity is the difference between the property’s fair market value and the unpaid principal balance of the mortgage and any liens. Equity increases as the mortgage is paid down and/or as the property appreciates in value.
Foreclosure is a legal process that is initiated by the holder of a mortgage or lien when the borrower is in default. The delinquent property is sold at public auction to recover the lenders investment.
A tax foreclosure is a legal procedure used by government agencies to enforce a lien against a property for non-payment of income taxes or property taxes. Government agencies hold tax foreclosures one to four times a year. The IRS will sometimes place a tax lien on a home or other real property and sell it at an auction to recover the unpaid income taxes.
Gross Rent Multiplier
A rough measure of the value of an investment property that is obtained by dividing the property’s sale price by its gross annual rental income. GRM is used in valuing commercial real estate, such as shopping centers and apartment complexes, but is limited in that it does not consider the cost of factors such as utilities, taxes, insurance, maintenance and vacancies. Other, more detailed methods commonly used to value commercial properties include capitalization rate (cap rate) and the discounted cash flow method.
The income approach is used to estimate the market value of income producing properties such as office buildings, warehouses, apartment buildings and shopping centers.
Income Tax Bracket
The rate at which an individual is taxed.
Internal Rate of Return
The use of various financial instruments or borrowed capital, to increase the potential return of an investment. The amount of debt used to finance assets; significantly more debt than equity is considered to be highly leveraged. Leverage is most commonly used in real estate transactions through the use of mortgages to purchase a home.
In real estate mortgages, the initial fee charged by the lender, with each point being equal to 1% of the amount of the loan. It can also refer to each percentage difference between a mortgage’s interest rate and the prime interest rate.
Loan-To-Value Ratio (LTV)
A lending risk assessment ratio that financial institutions and others lenders examine before approving a mortgage. Typically,
Calculated as: Loan to Value Ratio = Mortgage Amount / Appraised Value of the Property
Modified Internal Rate of Return
While the internal rate of return (IRR) assumes the cash flows from a project are reinvested at the IRR, the modified IRR assumes that postive cash flows are reinvested at the investor’s cost of capital, and the intial outlays are financed at the investor’s financing cost. Therefore, MIRR more accurately reflects the cost and profitability of an investment.
The formula for MIRR is:
Internal Rate of Return
The Net Income Multiplier or NIM is a factor that is used to estimate the market value of income producing properties. It is equal to the market value of a property divided by the net operating income or NOI. Example 1: A residential incomeproperty has an NOI of $15,000 and a market value of $150,000.
Internal Rate of Return
Net operating income (NOI) is a calculation used to analyze real estate investments that generate income.Net operating income equals all revenue from the property minus all reasonably necessary operating expenses.
Operating expenses are those expenditures that a business incurs to engage in any activities not directly associated with the production of goods or services (see an alternative definition at the bottom). These expenditures are the same as selling, general and administrative expenses.
Operating Expense Ratio
The operating expense ratio (OER) is a measure of what it costs to operate a piece of property compared to the income that the property brings in. Theoperating expense ratio is calculated by dividing a property’s operating expense by its gross operatingincome and used for comparing the expenses of similar properties.
Passive Activity Loss
Passive Activity Loss Rules’ A set of rules that prohibits using passive losses to offset earned or ordinary income. Passive activity loss rules prevent investors from using losses incurred from income-producing activities in which they are not materially involved.
Principal, Interest, Tax, and Insurance
Projected Cash Flow
Estimate of the timing and amounts of cash inflows and outflows over a specific period of time. A cash flow forecast shows if there will be a profit or if borrowing is necessary, how much and when. Also called cash flow budget or cash flow projection.
Achieve a substantial return on (money or property) after making a small initial investment.
Tax deductions can be the result of a variety of events that the taxpayer experiences over the course of the year. Tax deductions are removed from taxable income, also known as the adjusted gross income, and thus lowers the taxpayer’s overall tax liability.