It can be very intimidating to a novice investor who feels otherwise confident in their intellect to become lost in a conversation because the agent or seller is using terms they have not heard before.
Those agents and sellers are probably just trying to throw you off your game and rattle your confidence, so ask for clarification if someone tosses out a term you don’t understand.
Here are a few key real estate investing terms to get you started.
REO: This stands for Real Estate Owned, and it refers to real estate owned by a corporation such as a bank or asset management company because it was taken back by a lender through the process of foreclosure. REO properties are not owned by individuals who have an emotional attachment to them. You can sometimes get a good deal, but they also come with elevated risks of title issues and other problems.
NOI: Net Operating Income. This is the amount of income a property can theoretically produce via rent and other income collected from operations if the property does not have a loan against it. The NOI equals all revenue such as rent and other income from operations, minus all operating costs such as maintenance, insurance, utilities, and property taxes. All costs are subtracted except mortgage payments to determine a NOI.
Debt Service: This is one of those terms a real estate agent or other person might throw at you just to make you feel out of place. Often calculated annually, it is the cash necessary to cover interest and principle on the mortgage for that time frame.
DSCR: The Debt Service Coverage Ratio is a measurement of the cash flow that is available to pay the property’s current debt obligations, such as a mortgage. Put more simply, it is the number of times a property can pay its mortgage after all other expenses have been paid. Lenders typically want a DSCR of at least 1.25. You need to know your lender’s threshold when evaluating properties.
GRM: Gross Rent Multiplier. The GRM is a rough screening tool used to determine if a property is in line with similar properties. The ratio is determined by taking the purchase price divided by the annual gross rents of an investment property. For example, a $2 million dollar apartment building with annual gross rents of $250,000 has a GRM equal to 8 ($2,000,000 / $250,000).
The GRM is very fast to calculate but ignores vacancy, expenses, repairs, etc. It should always be used in conjunction with other screening tools.
Personal Guarantee: When you sign a Personal Guarantee on a loan, it means you are putting up your own home, bank accounts, and other assets to cover the loan, even if the loan is made to your LLC or other business structure. Be very careful about signing a Personal Guarantee.
Cap Ex: Capital Expenses are large expenses that contribute to the long-term value of the property. You need to have Capital Expense Reserves to cover major costs such as roof replacement, HVAC upgrades, and parking lot resurfacing. Be sure to set aside money each year to cover these necessary expenditures.
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