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Real Estate Investing and the Terms You Need to Know | Part 2

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.

Operating Expenses

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.

DCR

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.

NOI

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

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.

 

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Real Estate Investing

The Real Estate Investing Terms You Need to Know | Part 1

As you begin to dip your feet into the real estate investing field, you might notice that a lot of acronyms and terms are thrown around that aren’t widely understood by the general public. As a result, it’s important to define these conditions in order to help you make an educated decision when it comes to your investment. As a result, we decided to compile some terms and their definitions to help you with your next investing venture.

Cash Flow

We can start simple. Cash flow can be easily defined as the income based on the property. There are a few additional factors that cause variations in how we estimate cash flow. Typically, investors are focused on the before-tax cash flow or CFBT. As described on Wikibooks, “When you know the cash flow, you can figure your return on your investment, calculate the tax shelter, and evaluate the investment, in other ways.” Cash flow, for the most part, is relatively simple to calculate with little to no real estate investing experience, but it is essential to know this to make an informed decision.

PITI

As Ken Horst explains, PITI stands for “Principal (P), Interest (I), property Taxes (T) and Insurance (I). This is basically the “bottom line” or the minimum you need to calculate when thinking about purchasing an investment property with a loan.” This amount is usually calculated on a monthly and overall basis so investors can calculate their expenses and the overall profit they need to bring in or leverage in order to pay for the property. By understanding these costs, you can better gauge the loan you might need or the price you need to charge for rent each month.

GSI and GOI

Gross Scheduled Income and Gross Operating Income go hand in hand, but it’s important to remember that the two are not interchangeable. GSI refers to your optimal income if everything went accordingly and you never experienced changeover periods. As James Kobzeff describes it, “GSI is the annual rental income a property would generate if 100% of all space were rented and all rents collected.” Unfortunately, GSI is not a perfect means to estimate your income, because renters don’t always pay on time and apartments sometimes go unrented for extended periods of time. You can think of GSI as the goal and GOI as the actual amount. Kobzeff goes on to say, “Consider GOI as the amount of rental income the real estate investor actually collects to service the rental property.” This number includes the amount lost due to missed payments and other extraneous cases as well as additional income sources related to the property like laundry or vending machines.