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Key Real Estate Investment Concepts
APOD (Annual Operating Property Data)
An APOD is the real estate industry's standard format for showing a property's income and operating expenses. APOD's are used to calculate a property's net operating income. It does not account for debt service (mortgage payments) or personal tax liabilities, since both of these will vary from investor to investor. An APOD is considered the most widely accepted way to account for a property's financial performance. It results in a property's net operating income (NOI), which is used to calculate a property's cap rate.
Capital Expenses
Capital expenses are costs associated with making improvements that have a useful life of more than one year. These major expenses permanently upgrade the property rather than simply repair or maintain it and must be capitalized for tax purposes. Most properties will need some kind of capital budget. Before purchasing a property an assessment of all capital expenses should be made along with cost estimates for replacements and major repairs. This is to allow the investor to set money aside each month so that improvements can come out of operations rather than pocket. New or recently upgraded properties should still include a budget for replacing windows and floor coverings or other frequently changed items.
Capitalization Rate
Capitalization rate is the percentage used to express the relationship between a properties net operating income and its current value.Capitalization rate, or "cap rate," is used to measure the profitability of the property for the current or coming year. Because properties in the same real estate market generally have similar cap rates, investors use this number to insure that if purchased at asking price, the property compares favorably to other similar properties in the area. Generally the lower the cap rate the lower the risk and higher the value - but low cap rates also tend to indicate lower cash flow.
Cash Flow
Cash Flow is the amount of the property's income received less the amount of expenses paid out. Basically, cash flow is a property's checkbook. Income from rent, interest, and other sources such as parking fees are added. Expenses such as operating costs, mortgage payments, or repairs are deducted. However, cash flow does not take into account the owner's income tax liability. A property that is said to have "positive cash flow" generates enough income to cover all expenses and have money left over. "Negative cash flow" means that the income does not cover expenses, so the owner must draw from other sources to operate the property.
Cash-On-Cash Return
Cash-on-cash return is also called the equity dividend rate or return-on-investment (ROI). Showing you the ratio between a property's cash flow and the cash invested to buy the property it is generally used only for the first year of ownership. The cash-on-cash indicator allows buyers to compare a property against other types of investments. For example, a property that gives a 5% cash-on-cash might be a better use of investing dollars than a CD with only a 2% return.
Financing
Financing is the loan agreement between the borrower and lender. It may consist of one loan or multiple loans. The loan terms determine the buyer's interest rate, length of loan and loan type. The ability to finance the purchase of an investment property is a key advantage that real estate has over other types of investments. The financing arrangements you make to buy a property - how much you offer as a down payment, the interest rate you pay, etc. - will have a major impact on your monthly cash flow, equity build up, and on-sale gain.
Gross Rent Multiplier (GRM)
Gross rent multiplier, or GRM, is the ratio of a property's selling price to its gross annual rental income. As with cap rates, properties of the same type in the same real estate market tend to have similar GRMs. A property's GRM is used as a quick way to compare the value of a property to others in the same area.
Internal Rate of Return (IRR)
Internal rate of return is an analysis of rate of return using multi-year cash flows and net sale proceeds. This information is analyzed using discounted cash flow techniques. Where cash-on-cash provides the rate of return for one year, the internal rate of return (IRR) provides a method for evaluating the return over the life of the investment. The IRR is considered to be the best indicator of rate of return. Because the discounting process takes into consideration the time value of money and spans the length of the investor's entire holding period, it produces a more realistic rate of return than cash-on-cash.
Offer & Loan Scenario
Offer and loan scenario in DeedQuest is made up of an offer price (as opposed to the asking price) and a specific financing arrangement.
DeedQuest allows you to compare offer and loan scenarios for a particular property as well as compare properties. By specifying up to three different financing scenarios you can determine how different purchase prices and loans will affect the financial performance of an investment.
On-Sale Gain
On-sale gain is what the government taxes you on when you sell a property. This taxable profit is the difference between the property's adjusted basis and its selling price. Because your sale proceeds don't account for depreciation, you are taxed on how much you paid for the property and the amount of depreciation claimed on your previous year's taxes during ownership. This is important because this makes your taxable gain higher causing you to pay more in taxes.
Resale Value
The estimated future price a property will sell for. This will be determined by many factors, including appreciation trends in the area and improvements made. Ensuring that a property's resale value at least tracks inflation is critical. If a property cannot be sold for more than you paid for it (after adjusting for inflation), then you must seriously question the investment. Even if you plan to buy-and-hold a property for it's positive cash flow, your investing strategy may change or circumstances could arise that force you to sell.
Sale Proceeds
The sales proceeds are the sales price of an investment property, less the costs of selling the property (e.g., real estate agent fees) and outstanding loan balance. Put simply, sale proceeds are the actual amount of money you walk away with after selling a property and before taxes. How much of this money you keep after paying your taxes depends on a variety of factors.
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