Real estate investing is full of industry-specific terms and acronyms that are helpful to understand as you begin the process of investing in real estate. Here are definitions of the terms most common to real estate investment lingo.
- After Repair Value (ARV)
- Capitalization Rate (Cap Rate)
- Cash Flow
- Cash on Cash Return (CoC)
- 1% rule
- Retail Investors
- Short Term Rental (STR)
- Turn-key Property
After Repair Value (ARV)
ARV is an estimate of the value of the home after it has been brought to full market value. In order to achieve this, the home may need to be repaired, remodeled, or simply marketed in a more compelling manner.
Capitalization Rate (Cap Rate)
Probably the most common ratio in real estate investing, the capitalization rate, or “cap rate”, is found by dividing the net income of a real estate investment by the current value of the investment. The cap rate is always calculated using the current value of the asset, rather than the purchased value of the asset, so your cap rate will go up over time. When people refer to the “rate of return” in real estate, this is usually what they are talking about. Cap rate is one factor among many that should be considered. A high cap rate does not always mean it’s a great investment. Low building quality in a bad neighborhood with difficult tenants may offer a high cap rate, but like many investments, higher cap rates can come with higher risk.
Cash flow is money coming in, usually rent, minus the money going out, such as the mortgage payment or management fees. When investing in real estate, most investors look for a positive cash flow from a property. A property receiving $1500/month in rent with $1200/month in expenses would have $300/month in cash flow. It’s important to understand that cashflow isn’t everything. A portion of the mortgage payment each month goes to pay down the principal on the property, creating equity. This equity build up would not be factored into cash flow.
Cash on Cash Return (CoC)
Cash on cash return refers to the annual cash return of a property divided by the amount of cash invested. This assumes the investor is using a loan with a down payment. When a property is purchased outright, the CoC return is equal to the property’s cap rate. When a property is purchased using a loan, this number differs from the property’s overall return.
Equity is the difference between the current market value of a property and the amount owned by the owner on a mortgage (if any). As a mortgage gets paid off the owner’s equity grows.
The one percent rule was a popular investment strategy in many classic real estate investing books. While there are a number of variables and expenses to keep in mind, the rent on an investment property must be at least 1% of the purchase price to be considered a favorable investment asset. This strategy has waned in influence over the years because prices have gone up so substantially.
In Colorado Springs, a typical home may sell for $300,000. For that home to meet the 1% rule, it would have to rent for $3,000/month. In The Millionaire Real Estate Investor, one of the common books cited for this principle, the author is referencing homes with a sale price of $80,000. These would be considered a good investment at $800/month in rent. However, the author points out that this principal is far more difficult to attain when a home price goes over $100,000.
Rehabilitation / Reconditioning
Rehabilitation (sometimes shortened to “rehab” refers to the repairs that need to be done to make a property tenant-ready. Rehab can include minor fixes such as paint and lighting upgrades, but can also extend to more large-scale repairs such as roof replacement.
Also know as individual investors, these investors buy and sell investment assets for their personal account. Retail investors are defined in opposition to institutional investors. Retail investors generally invest at significantly lower amounts than institutional investors.
Short-term Rental (STR)
An investment property that is rented out for short periods of time, as little as a single day, on services such as Airbnb, up to as much as 3-5 months. This is distinct from traditional rentals or long-term rentals, which rent for a minimum of 6-months. Unless short-term rental is specified, it’s safe to assume the topic is traditional rentals.
A property that is rent-ready, and does not need any rehabilitation.