Making Money in Real Estate: The Terms You Need to Know
Like any business, real estate investing has its own lingo, and every potential investor should make sure to learn the proper terms related to investment property returns before beginning to search through real estate markets and look for rental properties. This article will introduce you to the most basic but also most important investment property returns words and expressions.
Wait! What? We want to define the word “cash” here?! Don’t we all know what it means? Well, obviously we are talking about “cash” as used in investment property returns. It simply refers to paying for your investment property with cash only and not taking a loan from the bank or any other source. Basically, there are two main financing strategies in real estate investing: cash and mortgage. Cash has some serious advantages: it is simple and straightforward; it allows you to act fast; and it doesn’t increase your costs. But to be honest — very few people can afford to pay for their income property in all cash.
The size of your cash investment is one of the most crucial numbers in real estate analysis and in the calculation of your investment property returns as it will determine many of the metrics for your rental property.
2. Cash Flow
Number 2 in our investment property returns dictionary is cash flow. This measure of investment property returns shows what goes in and out of an investment property in terms of cash. To be more specific, the monthly cash flow is simply the difference between the monthly rental income and the monthly costs associated with your property, so this is a metric for your monthly profit.
Cash Flow = Monthly Rental Income — Monthly Expenses
The rental income is the money that you will be able to charge your tenants for using your property. Expenses are trickier because you have to factor in the mortgage payments (if you didn’t pay for your property all cash) as well as the monthly share of property tax, property insurance, property management, maintenance, utilities, etc. Cash flow is one of the many investment property returns values that Mashvisor will provide you with for any of the thousands of available real estate properties.
Cash flow must be positive! You can say there are two fundamental types of real estate investors: those who go for cash flow and those who go for appreciation, the former being short-term oriented and the latter being long-term oriented. But even if you are interested in long-term gains from your investment property, it is a NO NO to invest in a property which will make you lose money (negative cash flow) instead of making money (positive cash flow). The worst case scenario you can afford going for to break even in the short run if you have a serious reason to expect long-term gains.
3. Cash on Cash (CoC) Return
The next term is our investment property returns dictionary is cash on cash return, or CoC return. This is something that is almost entirely used only in real estate investing, but in this business it is used heavily. In simple terms, this is a measure of the return that your investment property will bring you based on the cash amount that you initially invested.
CoC Return = NOI/Total Cash Investment
What is NOI? That’s the net operating income, and it is very similar to cash flow. It’s the rental income minus the expenses but is usually used on annual basis, unlike cash flow which is usually monthly.
Total cash investment includes several things:
- The cash you put towards the property price
- Closing costs
- Rehab costs
- Loan fees if you go for a mortgage
You should keep in mind that the CoC return will vary widely depending on the part of the property price that you pay in cash initially. In some cases, the CoC return will be higher for all cash investments; in other cases, the CoC return will be better for a mortgage. Mashvisor will provide you with an estimated CoC return for the available properties.
Generally speaking, the minimum CoC return you should go for is 8%, and many would say even 12%. On the other hand, there are real estate investors who would not even think about properties under 20%, but honestly, that’s not very realistic.
4. Capitalization (Cap) Rate
The capitalization rate, or cap rate, is another crucially important metric of investment property returns. Unlike the CoC return, the cap rate measures the rate of return of an investment property independent of the financing method.
Cap Rate = NOI/Property Price
We’ve already defined the NOI above. It’s the net operating income, remember? The property price is simply the price of the property which the seller will receive, regardless of the financing (cash or mortgage), closing costs, fixing expenses, and others. In this sense, the cap rate is even easier than the CoC return to calculate. But to make your life even easier and your investment decisions more straightforward, Mashvisor calculates this measure of investment property returns for you — for both traditional and Airbnb rental strategy.
There is a debate in real estate investing about how much the cap rate should be, but most experts agree on 8–12%. Keep in mind that similar to the CoC return, the cap rate varies across property types and real estate markets.
The last two terms in our discussion of investment property returns terms are two types of rental income.
5. Traditional Rental Income
There are two basic types of rental strategies: traditional and Airbnb. As Mashvisor’s investment property calculator shows, they yield very different investment property returns, so you should be careful when choosing the optimal strategy for you. Traditional rental income simply refers to the monthly income that you will be able to receive from renting your income property out to tenants for long-term stays.
6. Airbnb Rental Income
The Airbnb rental income, on the other hand, is the monthly income you will generate from leasing your rental property for short rentals — anything from one night up to one month. Some properties will provide you with higher traditional rental income, while others will attract more Airbnb rental income, depending on the property type and the market. Mashvisor’s investment property calculator will be particularly useful in this regard as it will give you instantly the expected traditional and Airbnb rental income for thousands of properties across the US, allowing you to decide on the best strategy in your case.
There is no optimal value for the rental income. Obviously, the higher the better, as your property will be more profitable. But as a bare minimum, your rental income should be able to cover your monthly property expenses at the least, so that you don’t lose money from your investment.
In conclusion, above are the 6 most popular and most important terms in any investment property analysis. To save yourself lots of time and headaches, make sure to use Mashvisor’s investment property calculator for your next investment property returns calculations.
Originally published at www.mashvisor.com on December 3, 2016.