Real estate is full of jargon (“DOM”, “HOA”, “pre-qual”, etc), and it can make an already complicated process even more difficult to navigate. That's why we created this glossary of key terms to help you fast-track your learning.
Capitalization Rate (Cap Rate)
The rate of return that an investors receives prior to debt service. It is calculated by dividing the net operating income by the purchase price.
Net operating income minus debt service.
Cash on Cash Return
This is the annual return that your equity is actually receiving. This is calculated by dividing the cash flow by your equity investment. Assuming that you are borrowing money at below the cap rate, you will have positive leverage so your cash-on-cash return will be higher.
The cost of the loan payments which includes both the principal and interest payments.
Effective Gross Income
The gross rent minus the vacancy & credit loss.
Upon sale or recapitalization, the gross cash flows including sale or refinance proceeds divided by the amount of equity in the transaction.
The total income from all residential and commercial tenants along with any auxiliary income such as laundry. Most analysts will also include any tenant pass through income which includes their contributions towards operating expenses.
Internal Rate of Return (IRR)
The rate of return over the lifetime of the investment. This factors in all cash flows received including the net sales proceeds on the exit. The returns are averaged over the number of years of the investment.
Net Operating Income
Effective gross income minus operating expenses. This is the net operating income on the property prior to debt service.
Expenses which are specific to the operations of the property. This includes real estate taxes, heat, water & sewer, electricity, insurance, repairs and maintenance, and management fees.
Return on Investment
This is what return the stabilized investment yields. It is calculated by dividing the net operating income once fully occupied by the total of the purchase price, renovation costs, and lease up costs.
Terminal Cap Rate
The exit cap rate that you project on a future sale.
Vacancy & Credit Loss
The percentage of income lost from vacancy or from tenants who don’t pay their rent. This also should factor in downtime to find a replacement tenant. 3-5% is typical but can go above 10%. Generally residential has the lowest vacancy rate, office in the middle, and retail the highest. This is definitely market specific so you will have to look at broker reports for the area.