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Key Real Estate Terms that Every Investor Should Know

By Edited Nov 13, 2013 0 0

 

There are many key real estate terms that every investor should know. Investing in real estate certainly can be confusing at first, mainly because people new to the sector are not familiar with specific terminology or vocabulary, and because of the fear of the unknown. I am here to tell you that investing in real estate is not all that hard - what it takes is a lot of learning, patience and motivation. You must pick up a lot of books and learn! After you do a couple of deals, you will gain the necessary experience and it will all perhaps seem much easier.

Stressing learning is very important. Have you ever heard the phrase, "those who have knowledge have the power?" This is true! Although I feel that investing in real estate is not exactly easy, I feel

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that if you take the time to learn and follow the advice of experts, you can succeed in this business! Reading books on real estate and investing in general is very important, I can't stress this enough. Also do check out this guide I put together on building wealth, I've shared some personal advice I think will help motivate you to get out there and start making money.

Key Real Estate Investing Terms You Must Know

Net Operating Income - This is how much money the property you are buying will make you less expenses - NOI is equal to a property's yearly gross income, less itsoperating expenses. Note that this DOES NOT include your mortgage payments on your property, that would be the term below

Cash Flow is Key!
Cash on Cash Return - This is the ratio of the annual before-tax cash flow to the total amount of cash invested, expressed as a percentage. You typically want a property that has a cash on cash return of 15 percent or better. If an investor purchases a $1 million dollar apartment building for example, with a $100,000 down payment. Each month the cash flow is $3,000, or $36,000 a year. The cash on cash return would be roughly 27 percent - very good. If the cash flow a month was $1,500, the yearly total would be $18,000. So the cash on cash return would be 18 percent, still pretty good!

Capitalization Rate or "Cap Rate" - this is the ratio between the net operating income produced by the property and its capital cost (the original price paid to buy the property).  Aim for property's that have a cap rate close to or above 10 percent. A $400,000 multi-family home, for instance, should have a NOI of $40,000 - this would give it a 10 percent cap rate. Lower cap rates are typically less attractive to investors because they are less profitable.

1031 Tax Deferred Exchange - This is a little advanced for beginners but I think it's very important to understand what this is because it can help you save a lot of money in the future. This allows you to defer paying taxes on a property you sold at a gain, if you are purchasing a new property that is "like" the old one. You are basically swapping your property for a new one (the new one will be a higher price!).

So let's say  you bought a home for $200k and it's now worth $300k after 5 years. You decide you want to sell. You would normally pay a tax rate on the capital gains (possibly 15-25 percent). Instead, you decided to trade up for a larger property and use the 1031, using the gains as a payment for the new property. The properties exchanged must be "like-kind", i.e., of the same nature or

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character, even if they differ in grade or quality. This strategy is used by many real estate professionals. They avoid paying taxes, and get that higher cash-flowing property at the same time!

Limited Liability Company -  A limited liability company (LLC) is a "flexible form of enterprise that blends elements of partnership and corporate structures. It is a legal form of company that provides limited liability to its owners in the vast majority of United States jurisdictions," according to Wikipedia. If you are a real estate investor it is imperative that you have your assets protected! An LLC is probably the most popular choice among investors. Partnerships, C and S corporations are also used. Consult with your lawyer and/or accountant to find out what is best for you.

I hope you learned something from these key real estate investing terms. There are other terms and vocabulary you should learn as well, so I recommend you pick up a good book on real estate if you are interested in investing. I recommend anything by author's Matthew Martinez and Robert Allen.


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