Since every industry has its share of jargon and terms, real estate is also acquainted with different terms and acronyms. Knowing these technical words can help investors invest optimally in real estate. However, some words are so specialized that they can be intimidating for newbie investors.
This article will break down some terms commonly used in the real estate investment market like terminal cap rate, net operating income, cash-on-cash return, CapEx, and many more.
How Terminal Capitalization Rate Helps Evaluate Real Estate Properties
When determining a property’s resale value at the end of a holding period, the term terminal cap rate, or terminal cap rate for short, is employed. Using the terminal capitalization rate as a percentage, the predicted annual net operating income (NOI) is divided by the terminal value.
The expected terminal capitalization rates are based on similar transaction data or elements relevant to the location and characteristics of a particular property. This is how it is used to evaluate real estate properties.
Following are some of the other technical terms related to the field of investment in real estate-
Capitalization Rate
Capitalization rate or cap rate measures the annual rate of return that an investor can get on real estate investment based on the profit expected to be generated by a particular property. The capitalization rate is between the net operating income (NOI) and the property’s purchase price.
To calculate the capitalization rate, net operating income (NOI) in the first year is divided by the property’s purchase price. If the investor uses financing, then loan costs are excluded from NOI.
Net Operating Income
Now that having the net operating income is essential to calculate capitalization and terminal capitalization rate, it is vital to learn about the same.
NOI is defined as the measure of the potential of a real estate investment property to be profitable. To calculate net operating income, all operating expenses, including repairs, property taxes, maintenance, HOA fees, etc., are to be subtracted from the revenue earned from the property. No mortgage payments are included in NOI.
Cash Flow
Cash flow is the money one can receive at the end of every month after paying off all operating expenses. A cash flow is positive when one earns more than one spends.
On the other hand, when costs are more than income, then cash flow will be negative. The consistently monthly rental payment encourages investors to invest in real estate property. Ideally, investing in a property can be perfect when you earn positive cash flows.
Cash-on-Cash Return
Cash-on-cash return is the ratio of annual pre-tax cash flow and the total amount of invested cash, which is expressed as a percentage. The relationship between yearly return and how much money one puts down is measured by cash-on-cash return.
Some benefits of the rental property owners that are not considered by cash-on-cash return include appreciation, depreciation, loan paydown, and other tax benefits. This figure can analyze an investment by considering returns based on the actual cash investment.
CapEx or Capital Expenditure:
CapEx, a short form of Capital Expenditure, is referred to as a new purchase or significant improvement through which the shelf life of the property is extended, including replacing a roof, adding finishing to the basement, painting the exterior, etc.
Also, equipment and supplies required to renovate the property are included in the capital expenditure. Often, these are one-time and major expenses that the property investor incurs.
Gross Rental Yield:
Gross rental yield can be calculated by dividing the property’s total income by the property’s purchase price and associated closing costs. An investor gets this before subtracting operating costs like HOA fees, insurance, maintenance, etc.
Conclusion
You can find yourself intimidated working in the real estate industry, specifically when hearing complex terminology and acronyms for the first time. It is significant to know basic terms when investing in real estate. Although the terms listed above are essential in the real estate industry, the jargon in this industry is vast. It is a growing list; you can explore the real estate terms to increase your knowledge.
