Last month we kicked off a series on real estate investing terms you need to know. We continue it this month with a few more words and acronyms that can help you make educated investments and have a better understanding the industry.
As James Kobzeff defines it, “Operating expenses include those costs associated with keeping a property operational and in service. These include property taxes, insurance, utilities, and routine maintenance.” Depending on how you structure your real estate investment, tenants sometimes cover utilities. That being said operating expenses refer to the ‘business’ end of it and does not include your initial down payment, mortgages, and etcetera that don’t pertain directly to keeping the property profitable and maintained.
Lenders use DCR or Debt Coverage Ratio to gauge how much or if a property’s rental income covers the monthly payments on the mortgage. It’s a means to ensure whether or not the buyer will generate enough revenue to pay them back and confirm that it’s a sound loan for them.
As Ken Horst says, “It’s calculated by dividing the NOI by the total debt. Ratios of 1.20 and higher are considered average.” It’s another helpful way for potential buyers also to confirm it’s a smart investment for them. In certain cases though, an investor may still purchase a property with a less than ideal DCR because there’s potential for expanding the property or it’s projected to rise in value over time. No matter the case, a poor DCR signals a riskier investment which is important to keep in mind.
Net Operating Income or NOI pertains to rental properties. To find this number take your yearly rental income and subtract the operating expenses (As a reminder, this doesn’t include a mortgage). Typically, investors and landlords calculate NOI annually. As Kobzeff says, “NOI is one of the most important calculations to any real estate investment because it represents the income stream that subsequently determines the property’s market value – that is, the price a real estate investor is willing to pay for that income stream.” NOI becomes the building block to calculating the Cap Rate and DSCR.
CCR refers to conditions, covenants and restrictions that are described in contracts, and explain what actions will and won’t fall into each parties’ set responsibilities. As Ken Horst explains, CCRs apply to a few different situations. Be it purchasing or renting a property, CCRs apply.
For example, pet policies and limitations would fall under this category be it an additional expense to the tenant or a size or breed cap based on the animal when it comes to rental agreements.