Whether you're buying your first home or starting to think about investing in real estate, the sheer number of unrecognizable words and phrases can be overwhelming. A crash course in real estate terms 101 is essential when you're new to the world of purchasing property.
If you're reading through a purchase and sale agreement, blog posts about real estate, or forums regarding property investment, the whole thing can seem like a foreign language.
Understanding the meanings of these terms can have a huge impact on each step in the process of purchasing real estate, selling real estate, and everything in between.
Let's dive in to help you get a firm grasp on the most important terms in the world of real estate.
A 1031 Exchange is a method you can use to defer paying capital gains taxes and depreciation recapture tax when you sell a rental property.
When you do a 1031 exchange, it means that you are "swapping" one investment for another. The term comes from Section 1031 of the Internal Revenue Code.
This is a mortgage with an interest rate that can change monthly based on benchmark interest rates. Commonly, there is a fixed rate period at the beginning of the loan before becoming adjustable.
Amortization is the process of repaying a loan fixed, regular payments according to a predetermined schedule. Understanding amortization can help you create a repayment schedule that benefits your finances and investment goals.
When you own an investment property, you might qualify for a depreciation allowance. This is one of the major tax benefits of real estate investing.
This is the annual rate either earned through investment or charged for borrowing. It is expressed as a percentage.
This is the amount of money that a property is evaluated to be worth. If you’re purchasing a property with a mortgage, your lender with likely hire a professional appraiser. An appraisal determines the loan-to-value ratio (LTV).
Appreciation is a property’s increase in value over time. This is one of the two ways you can build equity in addition to paying down your mortgage.
For tax purposes, a public assessor will determine the value of your property in the form of an assessed value.
There are four building classifications: A, B, C, and D. This can help investors make sense of market data and differentiate properties. "A" properties are in higher demand and more expensive, while "D" properties are the least in demand and the least expensive.
A buyer’s agent is a real estate agent that represents the buyer in a real estate transaction.
When buyers have an advantage over sellers in the real estate market, it’s known as a buyer’s market. This can occur when there is an increase in housing supply, a decrease in demand, or both.
Capital expenditures, or CapEx, are major improvements or purchases that extend a property’s lifespan. These are usually one-time expenses, such as installing a new furnace or replacing a roof.
Capitalization rate is a term that measures an investment's annual rate of return. To find the cap rate of a property, you divide the net operating income (NOI) by the purchase price.
When you sell a property for a profit, it’s known as a capital gain. Short-term capital gains occur when you buy and sell a property within one year or less, and long-term capital gains occur when you buy and sell a property over the course of more than one year.
Most people that are selling a primary residence don’t have to pay capital gains tax. However, investors don’t qualify for the same exemptions. Capital gains tax is one of the biggest tax hits you might face when selling a rental or investment property. Luckily, there are ways to avoid capital gains tax on rental property.
Cash flow is the amount of money an investment property produces each month minus the monthly expenses it takes to operate the property.
Some lenders require cash reserves when you take out a mortgage to buy a property. This refers to funds you will still have after the down payment and closing costs that you could put towards emergencies in the future if necessary.
This is the ratio between the annual cash flow of an asset and the down payment of the property.
When legal ownership of an asset is not in question (meaning there aren’t any liens from creditors or others), the title is considered clear.
When you buy a property, there are additional costs that need to be paid at closing. These might include homeowners insurance, property taxes, points, mortgage insurance premiums, loan origination fees, and more.
Certain types of properties qualify as commercial rather than residential real estate. These include retail, industrial, office, special use, and large apartment buildings. Land also can be considered commercial real estate.
A CMA is a method through which you can compare similar properties in the same area as a property you’re interested in. Through this analysis, you can determine the market value of the property.
This is a condition that is set on a property’s purchase agreement. Frequently, they are accompanied by an option for the buyer to terminate the contract. Common contingencies include financing contingencies and inspection contingencies.
Conventional loans are any mortgages that the government doesn’t guarantee or insure.
This is a ratio that compares how much of a property an investor owns to the amount that is still owed on the loan.
Depreciation is a property’s decrease in value over time.
In real estate, a due diligence period refers to a period of time after the contract has been signed in which the buyer can determine whether they want to move forward with the transaction.
When you make an offer on a property, you typically make an earnest money deposit. This is a way to show “good faith” that you actually intend to purchase the property.
This is a term that can help investors understand the value of a rental property. It is calculated by taking your potential gross rental income and adding it to other income before subtracting credit costs and vacancy of a property.
The difference between the current market value of a property and the amount of money the owner still owes on the loan is known as the equity.
Escrow is when a third party holds funds that will be released upon the closing of a property.
This is a term that describes a property seller that hasn’t hired a real estate agent to assist in the process. This can present good opportunities for a buyer but also presents a certain amount of risks.
The Fair Housing Act is a Federal law that makes it illegal to discriminate against anyone due to their “race, color, national origin, religion, sex (including gender identity and sexual orientation), familial status, and disability” in the renting, financing, buying, or selling of housing.
This is the amount of money that a property is determined to be worth based on objective purchases or the marketplace.
Fee simple is a real estate legal term that refers to the highest form of ownership. It means that a person has “full and irrevocable ownership” of a piece of property and any buildings that are on the property.
This is a mortgage loan where the interest rate is fixed for the life of the loan.
This is the ratio of a property’s price to the annual rental income it brings in before subtracting expenses.
Gross rental income is the amount of money that expect you will be able to receive from a rental property by taking the market into consideration and assuming no vacancy.
These are a type of due that must be paid by members of a homeowner’s association. Investing in HOAs requires specific considerations, as there are some high pros and high cons.
This is a type of loan that is primarily used in real estate transactions. These loans are secured by real property and the lenders involved aren’t usually banks, but instead, companies or individuals. Hard money loans are usually taken out for a short time and are often considered loans of last resort.
An inspection report is generated by a professional home inspector. After visiting the property and evaluating the house, they will deliver a report that includes information about the home’s condition and any problems with the major systems of the property.
Interest is the money that you pay in order to borrow money.
This is a metric used to evaluate real estate over time and analyze capital budgeting projects.
Leverage is the use of debt to increase an investment’s potential return on investment.
Lenders charge loan origination fees in order to be compensated for the application of a mortgage loan.
The LTV ratio is one of the ways that lenders determine whether they will loan you money. This is a measure that compares how much money you want to borrow with the property’s appraised value.
Also known as a traditional rental, long-term rentals are rented out for an extended period of time rather than a brief period of time. What constitutes a long-term rental differs depending on your location and who you ask, but many investors use the definition that a long-term renter signs a lease for a twelve-month period or more.
A mortgage is a loan that is most commonly used to buy a piece of real estate. This is a secured loan, as the property itself is the collateral.
Most U.S. homebuyers use mortgages to buy their homes.
A multi-family home is a single building that accommodates more than one household living separately. The building is divided into as few as two or as many as four units. When a building has more than four units, they are usually considered to be commercial properties rather than multi-family homes.
The National Association of Realtors is a trade association in the United States for professionals that work in the real estate industry. It's one of the biggest trade associations in the country with more than 1.4 million members.
This is a calculation that investors can use to determine how profitable a real estate investment might be. You can find the NOI of a property by adding up all of the revenue from the property and subtracting all of the necessary expenses to operate the property.
An off-market property can fall into one of two camps.
The first is that the property is for sale but isn't listed as such. The second is that it simply isn't for sale.
If you're able to find off-market properties that are for sale but aren't listed on the MLS, you might be able to get a deal on the purchase or snag a property in a hot market versus buying it when it's on the open market.
This is a commonly used acronym that stands for "principal, interest, taxes, insurance."
When you make a mortgage payment, some money is going to each of these costs. PITI can help both a buyer and a lender determine how affordable an individual mortgage is because it represents the total monthly mortgage payment rather than simply the principal and interest.
Mortgage lenders use the term "points" to describe upfront fees that they charge as a part of a property purchase. One point equals one percentage point of the loan amount. For example, one point is 1%.
When you take out a loan for a specific amount of money, you pay back both principal and interest. The interest is the cost of borrowing the principal, while the principal is the actual money that you agreed to pay back originally.
Private mortgage insurance is a specific type of mortgage insurance that buyers are often required to pay when they purchase a property with a conventional loan. This insurance is intended to protect the lender, not the borrower if the borrower doesn’t make loan repayments on time.
This is usually required when a buyer makes a down payment of less than 20% of the purchase price.
Privately owned property is taxed based on its market value. The local government calculates the amount of property tax that is due and the property owner must pay the tax.
This is a legally binding contract that exists between the buyer and seller of a piece of real estate. In the document, the purchase price and additional conditions are outlined.
Real-estate-owned (REO) property is usually owned by a government entity or a bank. These properties commonly didn’t sell during the foreclosure period and are now owned by a mortgage investor, bank, mortgage lender, or government entity.
A real estate agent is a licensed professional who represents individuals in a real estate transaction. While the terms "real estate agent" and "realtor" are often used interchangeably, they actually aren't synonymous.
A realtor, technically, is a member of the National Association of Realtors (NAR). A real estate agent, on the other hand, doesn't necessarily have to be a member of the NAR, though they frequently are.
When you replace or revise the terms of an existing mortgage loan, it’s known as refinancing.
This is an agreement in which an individual commits to renting a piece of real estate for a specific time period. The renter then has the option to buy the property before the end of the lease period if they choose to do so.
In some instances, but not all, a portion of the rent payments is applied to the final purchase price if the renter decides to buy the property.
This is a useful metric for real estate investors, as it helps to measure how much money can be made from an investment based on the initial capital invested. To find the return on investment, you divide the profit received from the investment by how much money you spent on it.
A single-family home is a freestanding home that sits on its own land. Designed to be occupied as one single dwelling unit, single-family homes usually have unshared utilities, unshared walls, and only one kitchen.
That being said, the U.S. Census Bureau provides a broader definition by including houses that are also semi-detached, townhomes, or row houses. Under this definition, single-family homes must not have shared utilities, heating or cooling systems, and must be separated by a ground-to-roof wall. Lastly, there also can’t be units above or below the dwelling for it to be considered a single-family home.
When the real estate market favors sellers, it’s known as a seller's market. This can occur when there is more buyer demand than supply.
A short sale occurs when a seller lists a house for less money than they owe on the mortgage. This commonly occurs only when a homeowner is financially distressed and is trying to avoid having their property foreclosed. When a property is sold in a short sale, all of the proceeds go to the lender.
A short-term rental is a property that is rented out for short periods of time. These rentals are commonly furnished and are also known as vacation properties.
Some real estate investors choose to primarily have short-term rentals, while some prefer traditional rentals. Others, still, might own a mix of the two.
Short-term rentals can be rented out through short-term rental sites like Airbnb and VRBO. Owners also might choose to rent their properties to demographics such as traveling nurses or professionals in markets that can support such properties.
Title insurance is a type of indemnity insurance that protects buyers and lenders from losses that can stem from any defects a property’s title might have. Lender’s title insurance is the most common kind of title insurance. This means that the borrower is buying the insurance in order to protect the lender.
There is also something known as owner’s title insurance. This is commonly purchased by the seller in order to help protect the equity the buyer has in the property.
A turnkey property is a piece of real estate that is move-in ready. This term can refer to any type of residential real estate, whether it be a house, duplex, or apartment.
There are also turnkey property companies that purchase properties below the market rate and rehab them. They then sell them to investors and provide property management for the properties.
The vacancy rate is the percentage that compares the amount of time that rental property was rented out versus how long it was vacant. You can find the vacancy rate by multiplying the number of vacant units by 100 and then dividing the resulting number by the total number of rental units on the property.
If the vocabulary of real estate purchasing and investing is completely new to you, don't fret. While it can seem like an impossible mountain to climb at first, once you start to grasp some of these basic definitions the others start to fall in place as well.
In the world of real estate, knowledge is power. You'll find that the more you learn and research, the more capable you are of making decisions that support your personal and financial goals.
When you're buying a rental property for the first time, one of the most valuable things you can do is run the numbers. While it can be tempting to make a decision based on a gut feeling, it's essential to take a look at things from a dollars and cents standpoint. This is, ultimately, how you can build a sustainable and successful real estate business over time.
If you have a prospective property you're thinking about buying or you want to analyze the current state of your existing portfolio, use our rental property calculator to gain valuable insight into the cash flow, IRR per year, total return, and more for a specific property.
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