Every industry has its share of jargon and acronyms, and real estate is certainly no exception. This can be intimidating to property investing newbies, so we’re breaking down some common real estate investment terms in a reader-friendly glossary.
Check out our list of real estate investment terms every investor should know and add some new lingo to your lexicon. If there’s anything else you’d like to see on this list, Tweet us @Roofstock.
Term: Cap Rate
Definition: Capitalization rate, or cap rate for short, is used to measure the annual rate of return on a real estate investment based on the profit that property is expected to generate. Simply put, it’s the ratio between the net operating income (NOI) and purchase price. Cap rate is calculated by dividing net operating income (NOI) in the first year by the property purchase price. (NOI excludes loan costs if you used financing).
Example: Say you purchase a property for $150,000. The expected NOI in the first year is $12,000.
$12,000/$150,000 = 0.08
Cap rate: 8%
Why it matters: Cap rate is one piece of the puzzle to include when evaluating an investment property. Lower-yielding properties tend to be safer investments, while higher-yielding homes typically come with a little more risk. Both types of properties potentially have a place in your rental portfolio—it's just a matter of why you're investing in rental income properties and what you hope to achieve. Are you looking for higher monthly cash flow, more stability, or something in between? In theory, cap rates can signify varying levels of risk. Higher cap rates may correlate to a higher amount of risk in the purchase, and vice versa. At Roofstock, our marketplace features properties with a variety of cap rates that generally range from 3%-12%.
Term: Net Operating Income
Definition: Net operating income (NOI) is a measure of a real estate investment property’s potential to be profitable. It’s calculated by estimating the property’s revenue and subtracting all operating expenses such as repairs, maintenance, property taxes, HOA fees, etc. NOI does not include mortgage payments.
Why it matters: NOI allows you to analyze properties of all different types without looking at financing terms. NOI is also required to calculate cap rate.
Revenue - all reasonably necessary operating expenses = NOI
Term: Cash Flow
Definition: Cash flow is the amount of money you can pocket at the end of each month, after all operating expenses (including loan payments) have been paid. If you spend less money than you earn, your cash flow will be positive. If you spend more money than you earn, your cash flow will be negative.
Rental income - all operating expenses (including loan payments) = Cash flow
Why it matters: Consistent monthly rental income is one of the most appealing reasons to invest in real estate. Ideally, an investment property should be cash-flow positive. This means rent is higher than the monthly mortgage, which provides a steady stream of passive income. This passive income can go toward maintenance expenses, the down payment on another investment property, or a savings account.
Term: Cash-on-Cash Return
Definition: This figure is the ratio of annual pre-tax cash flow to the total amount of cash invested, expressed as a percentage. Cash-on-cash return measures the yearly return in relation to how much money you put down. It doesn’t take into consideration some of the other benefits of rental property ownership, including appreciation, loan paydown, depreciation and other tax benefits. Whereas calculations based on standard ROI take into account the total return on an investment, cash-on-cash return only measures the return on the actual cash invested. It’s the cash you’ve got left after one year, divided by the cash you’ve invested.
Annual pre-tax cash flow / actual cash invested = Cash-on-cash return
Why it matters: Cash-on-cash return is one way to analyze an investment by focusing on returns based on the actual cash invested. It also helps you understand the effects of leverage, and what your cash-on-cash return would look like if using a mortgage loan to finance part of the investment.
Term: CapEx
Definition: CapEx, or Capital Expenditures, are defined as new purchases or major improvements/renovations that extend the life of a property, such as replacing a roof, adding an extension or finishing the basement. This term also covers equipment and supplies required to make these improvements. Generally these are one-time, major expenses. Think of it this way: Routinely re-painting your rental home after tenants move out is not a capital expenditure. Installing a new furnace is. Tip: All Roofstock Certified investment properties include full inspection reports with estimated turn costs so buyers can be aware of these expenditures up front.
Why it matters: Most parts of a house will eventually need replacing. Though the big-ticket items may only be needed every 20 years, it’s important to know there will come a time where you have to pay $1,200 to replace a bathroom floor, or $4,500-$10,000 to replace the roof. Just remember—these repairs/improvements ultimately extend the overall life and value of your investment property.
Tip: When it comes to taxes, capital expenditures and routine maintenance are deducted differently. While major improvements and upgrades are recovered through depreciation, general fixes or maintenance that keep a rental home in good operating condition are classified as “repairs” and can be written off in a single tax year.
Term: 1031 Exchange
Definition: When you sell an investment property, you’ll likely have to pay some hefty capital gains taxes at the time of the sale. However, under Section 1031 of the U.S. Internal Revenue Code, a taxpayer may defer (pay at a later date) capital gains and related federal income tax liability on the exchange of certain types of property. To put it in layman’s terms, that means you can pay taxes on the income from the sale of a property at a later date if you take that money and put it towards purchasing another property or portfolio of properties of equal or higher value.
“Some of the most astute real estate investors have executed a 1031 exchange for a single-family home in a highly appreciated market such as California in order to purchase a portfolio of rental properties with lower volatility, more affordability and/or better cash flow in another market, which can generate greater returns over time.” - Ted Farry, President of Conatus Real Estate
Why it matters: If you’re primarily investing in single-family rental properties, the 1031 exchange gives you a lot of flexibility to buy and sell assets without having to worry about being taxed at the point of every sale. This gives you more purchasing power to scale your real estate investment portfolio.
Term: HOA fees
Definition: A homeowner's association is an organization that creates and enforces rules for the properties located in a subdivision, community or condominium. Purchasing property within an HOA's jurisdiction means you automatically become a member and are required to pay monthly HOA fees to assist with maintaining and improving properties within the association.
Why it matters: When evaluating rental investment properties for purchase, it’s important to know if there will be HOA fees since these cut into cash flow and may need to be factored into your rental rates. Be sure to ask what the HOA fees cover and how they compare to other HOA fees in the area.
Tip: Roofstock provides property details and financial information upfront for all of the properties listed on its marketplace, including HOA information (when applicable).
Term: Gross Rental Yield
Definition: Gross rental yield is the total income generated by a property, divided by the price paid for the property and associated closing costs. This is what you get before deducting operating costs (maintenance, property management, insurance, HOA fees, etc).
Why it matters: Gross rental yield provides investors with a quick reference for an annualized return on an investment.
Monthly rent x 12 / purchase price and associated closing costs = Gross yield
Term: Appreciation
Definition: Appreciation is an increase in the value of an asset over time. The increase can occur for a number of reasons, including increased demand or weakening supply, or as a result inflation or interest rate fluctuations. This is the opposite of depreciation, which is a decrease in the value of an asset over time.
Why it matters: Like a property’s cap rate, appreciation is an important piece of the puzzle when evaluating the overall appeal of an investment property. As the market value of your rental increases, so does ROI.
Tip: The Roofstock marketplace makes it easy to view expected appreciation over time for any property.
Term: Adjustable Rate Mortgage (ARM)
Definition: An adjustable rate mortgage (ARM) is a mortgage that does not have a fixed interest rate. Rather, an ARM can change monthly throughout the life of the loan based on the benchmark interest rate, which fluctuates based on capital market conditions. The initial interest rate is typically fixed for the first few years and then resets periodically.
Why it matters: As an investor, you need to know what your potential risks are. With an ARM, your monthly mortgage payments could increase or decrease depending on market conditions.
Term: Fixed-Rate Mortgage
Definition: A fixed-rate mortgage is a mortgage loan that has a predefined interest rate for the entire term of the loan that never changes. The monthly payment for a fixed-rate mortgage is the amount that needs to be paid by the borrower every month to ensure the loan is paid off in full with interest at the end of its term.
Why it matters: Fixed-rate mortgages are appealing because monthly mortgage payments stay the same, which makes budgeting and planning for future investments a little easier.
Term: Equity
Definition: Equity is the difference between the current market value of the property and the amount that you (the owner) owe on the property’s mortgage. If you were to sell your investment property, the equity would be the money you receive after paying off the mortgage in full. This value can build up over time as the mortgage balance declines and the market value of the property appreciates.
Why it matters: Building home equity is a great strategy for building long-term wealth. At some point you’ll want to tap into your home equity, whether it’s to fund your retirement, upgrade to a different home, help pay for a major life event, etc. The long and short, this number is your friend and you want it to be growing.
Term: Turnkey Property
Definition: A turnkey property is a home or apartment that is completely, or very close to move-in ready.
Why it matters: Turnkey properties are appealing from an investment standpoint since investors can purchase a property and rent it out immediately without making any major repairs. Even if there are some improvements that need to be made at some point, investors can start earning rental income right away as long as the property is move-in ready, It goes without saying: Do your research before buying a property from a turnkey provider. Read reviews, comb through case studies, and look for as much due diligence up front as possible.
>>Related: See how real estate investing gives Roofstock investor Lenny Hu the freedom to choose jobs he likes doing, rather than the jobs that pay him the most.
Term: Capital Gains Tax
Definition: Capital gain or loss is the difference in the value of a property compared to its purchase price. If there is a gain, it is realized after the asset is sold. A short-term capital gain is one year or less; a long-term gain is more than a year. Both must be claimed on your income taxes, but short-term capital gains have a higher tax rate than long-term capital gains.
Why it matters: Understanding how your real estate investments are taxed is important if you’re looking to optimize performance and returns.
Term: Debt-to-Equity Ratio
Definition: In real estate, debt-to-equity (D/E) ratio is a measure of ownership. This ratio helps you determine how much of your property is actually yours (if you took out a mortgage to finance it) and how much you owe in debt.
Why it matters: This is important because it paints a more holistic picture of your investment. It tells you how much capital you have invested and how much you owe, which gives you a rough idea of how much you’ll walk away with when you decide to sell. It also matters if you’re looking to refinance your investment property or borrow against it with a home equity line of credit, as lenders will consider your debt-to-equity ratio as a measure of creditworthiness.
Term: Escrow
Definition: Escrow is when an impartial third party holds on to something of value during a transaction. When you make an offer on a property, you will pay a portion of the down payment ahead of time. This payment will be held by an impartial third party in a separate bank account until the contract has been negotiated and the deal has been closed.
Why it matters: Escrow helps remove risk from transactions for both parties. The escrow agent holds the money exchanged in a purchase until all agreed upon conditions between the buyer and seller are met. Once these are completed, escrow funds are released to the seller.
Term: Closing Costs
Definition: Closing costs are the fees paid at the end of a real estate transaction. These fees vary depending on where you live, the property you buy, and the type of loan you choose. There are costs associated with inspections, transfer of title, loan origination fees, etc.
Why it matters: It’s important to budget accordingly for your closing fees so you have enough cash on hand at the time of purchase. Home buyers will typically pay between 2%-5% of the purchase price of the home in closing fees.
Term: Internal Rate of Return (IRR)
Definition: This is a common real estate investment term you’ll see when browsing rental properties or crowdfunding websites. The internal rate of return (IRR) is a measurement of a property’s long-term profitability that takes into account the annual net cash flow and the change in equity over time.
Why it matters: IRR is the single best estimate of your asset’s performance over the entire time that you plan to hold it. It allows you to evaluate investments that may have different cash flows or appreciation potential.
Term: Inspection Contingency
Definition: An inspection contingency is a term in the purchase agreement that lets the buyer:
- Hire a home inspector to look at the home
- Receive a report from the inspector on the home’s condition and issues
- Negotiate a sharing of the new costs with the seller or terminate the purchase agreement and get their earnest money deposit back
Why it matters: The inspection contingency contains a termination date which the buyer must adhere to. The buyer must have the inspection completed, review the report and negotiate with the seller on the next steps within this agreed upon timeframe. If the termination date passes and the buyer has not terminated the agreement or come to an agreement with the seller, the buyer must continue based on the terms in the initial purchase agreement.
Term: MLS
Definition: The Multiple Listing Service (MLS) is a private offer of cooperation and compensation by listing brokers to other real estate brokers, according to the National Association of Realtors. There are over 800 MLSs throughout the United States and some larger metropolitan areas, such as Los Angeles, have more than one MLS service.
Why it matters: Only licensed real estate agents who are members of their local and national real estate association may list property on the MLS. As a real estate investor, that’s important to know for a couple of reasons. First, REALTORS® must follow certain rules of conduct and ethics, such as disclosing property defects and not misrepresenting information about the property. Second, not all property available for sale may appear on the MLS, because only licensed real estate agents who are also members of their real estate association are allowed to list on the MLS.
Term: FSBO
Definition: For Sale by Owner (FSBO) is a term used to describe a real estate owner that is selling his or her property without using a real estate agent or listing the property on the MLS. FSBO listings are often seen toward the peak or bottom of the real estate market cycle. Owners selling at the top of the market don’t see the need to pay a real estate commission when there is more demand from buyers than there is supply of houses. On the other hand, FSBOs selling at the bottom of the market may have little or no equity in their property, and simply can’t afford to pay a real estate agent commission.
Why it matters: Buying a FSBO property may offer a good opportunity for a buyer if part of the real estate sales commission the seller is saving is passed through to the buyer. For example, if a seller lists his house on the MLS with a real estate agent, the seller would probably pay a real estate commission of 6%. On a house with a fair market value of $150,000 that’s a fee of $9,000 split between the seller’s agent and the buyer’s agent. By not using a real estate agent, the seller is ‘saving’ $9,000, which means some or all of that money could be used to reduce the sales price of the house. However, buying a FSBO also comes with a certain amount of risk. That’s because while a real estate agent listing property on the MLS is governed by specific rules of conduct and ethics, somebody selling a for sale by owner is not.
Term: FDR
Definition: Formal Dining Room (FDR) is a room for dining that is separate from an eat-in kitchen or breakfast nook found in many open floor plans in houses built today. FDRs are usually adjacent to the kitchen to make access easier.
Why it matters: Having a rental property with an FDR may or may not be a benefit, depending on the characteristics of your target market tenant. If families make up a large percentage of the rents in a market, having an FDR would be a perceived value for the tenant, and may also allow you to charge a higher rent. By contrast, if your renter market is made up of students, young professionals, or millennials who order take-out and eat in front of the TV, having a formal dining room probably would not be seen as a benefit by the tenant.
Term: CMA
Definition: Comparative Market Analysis (CMA) is a report that shows active and sold listings, listings taken off of the market, and listings that expired without being sold during a specific time period and in a specific neighborhood or geographic area. CMAs are usually generated by real estate agents using data from the MLS. Because not every property bought and sold is listed on the MLS, a CMA may lack some specific property data, but normally will serve as an accurate guide for current market trends.
Why it matters: Sellers use a CMA to help determine asking price and fair market value, market demand by reviewing the number of days it takes other similar listings to sell, and how motivated buyers are by analyzing at the ratio between the listing price and the sales price. Buyers benefit from the same information on a CMA, and also by looking for property that has been taken off of the market and then relisted. Sellers who are unsuccessful selling their property during the first listing period may be more motivated the second time around, and also may be more realistic with the terms and contingencies when presented with a purchase offer from a qualified buyer.
Term: ABR
Definition: Accredited Buyer Representative (ABR) is a designation for real estate agents who have received special training and practical experience required by the Real Estate Buyers Agent Council, or REBAC. An ABR normally specializes in representing only buyers rather than working with sellers to list property.
Why it matters: In addition to completing a special designation course, an ABR must have completed at least five transactions where they acted solely as a buyer representative. As a buyer, that’s important because you know you won’t be working with a brand new real estate agent who may be learning the business at your expense. Another benefit of working with an ABR to buy property is that you have a real estate professional solely on your side instead of the seller’s. Normally an ABR is compensated from the co-broke (or cooperative commission split) from the seller’s agent for selling the house. However, some ABRs may charge an additional fee or require their client to pay a specific amount in the event that a transaction does not close or the buyer does not buy anything within a certain time period.
Term: NAR
Definition: National Association of REALTORS® (NAR) is the largest trade union in American with about 1.4 million members working in all fields of the residential and commercial real estate industries. There are around 1,200 local associations/boards, and 54 state and territory associations of REALTORS®.
Why it matters: The main purpose of the NAR is to help its members become more successful and profitable in their businesses by better serving their clients. NAR members inlcude real estate agents (salespeople) and their employing brokers, property managers, leasing agents, appraisers, and counselors. The National Association of REALTORS® requires its members to maintain the highest standards of professional ethics and conduct between themselves, when working with clients, and with the general public. Not all licensed real estate agents are members of the NAR or a local real estate board or have access to the MLS. So, before agreeing to allow an agent to represent you in the sale or purchase of real estate, always ask about their professional affiliation if NAR membership is important to you.
Term: PITI
Definition: PITI is an acronym for a mortgage payment that includes Principal, Interest, (Real Estate) Taxes, and Insurance. The monthly payment of most residential mortgages is PITI.
Example: $1,000 / month principal and interest payment + $40 / month homeowner’s insurance + $200 / month property taxes = $1,240 PITI per month
Why it matters: PITI has a significant effect on your total monthly cash flow, in addition to normal operating expenses. Sometimes real estate investors only calculate the monthly mortgage payment based on loan interest, but forget about the additional expenses of property tax and insurance on the house. When this happens, cash flow is overstated along with the profit potential of the rental property. Other extra monthly costs to add to the PITI include any mortgage insurance premium (MIP) and the monthly HOA fee if the property is in a homeowners association.
Term: FMV
Definition: Fair Market Value (FMV) is the reasonable price that a property would sell for on the open market when both buyer and seller are reasonably knowledgeable, free of undue pressure to complete the transaction, and are behaving in their own individual best interest. So, FMV should reflect an accurate valuation of value or worth at a specific point in time.
Why it matters: Knowing what the FMV of a property is helps a buyer understand if they are paying the right price for a property, and a seller understand if they are leaving money on the table. There are several ways for an investor to determine the FMV of real estate including a third-party appraiser, a CMA done by a real estate agent, and a BPO (broker price opinion). Oftentimes an agent or broker will offer to provide a free CMA or BPO as a way of gaining future prospective business. Property tax assessments and insurance claims often use FMV, although it’s important to note that there is a difference between Appraised Value for property tax purposes and Fair Market Value for buying and selling real estate.
Term: LTV
Definition: Loan-to-Value (LTV) is a percentage that measures the total debt or leverage on a property compared to the market value. In most cases, real estate investors will use a conservative LTV of no more than 75% to 80%. A property with an LTV greater than 80% can be described as being over leveraged, creating the risk of potential negative cash flow due to a larger mortgage payment.
Example: LTV = $75,000 loan / $100,000 market value = 75% LTV
Why it matters: In general, the lower the LTV is the less risk there is of having negative cash flow from a rental property. A low mortgage payment gives an investor the opportunity to set more net cash aside for capital repairs or a period of extended vacancy if the property takes longer to rent than anticipated. A conservative LTV also minimizes the risk of an investor having negative equity – sometimes described as being “upside down” - in the property during a downward real estate cycle where market values decrease but the loan amount stays the same.
Term: RTO
Definition: Rent to Own (RTO) combines a real estate lease agreement with a real estate purchase agreement. For example, under an RTO agreement a tenant might pay $1,200 per month, with $1,000 being treated as normal rental income by the landlord and $200 credited toward the purchase price of the house agreed to in the purchase agreement.
Why it matters: There are two main scenarios where a real estate investor may consider using entering into an RTO. First, a rent to own agreement can be used by a first-time investor as a way to purchase a property over time. This approach is a good way to become a real estate investor that requires very little cash up front. An RTO can also be used as a gradual exit strategy for a property owner that wants to sell, but not right away. Until the property is purchased by the tenant, the investor benefits from having monthly cash flow that is higher than what the normal rent would be. Another term for RTO is Lease-to-Purchase. Regardless of what the transaction is called, it’s a good idea to have an independent third party such as an escrow company accept, record, and disburse the monthly payments of an RTO to help ensure that the flow of funds is properly tracked.
Term: FHA
Definition: Federal Housing Administration (FHA) is a government agency that insures FHA mortgage loans. FHA loans are popular with first time home buyers because they allow for low down payments of 3.5% and low credit scores of around 580, or even lower credit score if a slightly higher down payment is made.
Why it matters: The FHA doesn’t make loans directly. Instead, borrowers can obtain an FHA loan from an FHA approved lender. In exchange for the more lenient lending requirements of an FHA mortgage, a borrower must pay a mortgage insurance premium (MIP) to protect the lender in case the borrower defaults. FHA loans are easier to qualify for because they require lower down payments and are less strict with credit score requirements. Another advantage of an FHA loan is that it is an assumable mortgage. So, real estate investors with credit blemishes or who do not want to minimize the size of the down payment as part of their overall investment strategy may look for sellers who have an existing FHA loan on their property.
Term: CRB
Definition: Certified Real Estate Brokerage Manager (CRB) is a professional designation designed for experienced owners of real estate firms, brokers, managers, and supervisors who want to raise their professional standards and improve the operation of their business and branch offices.
Why it matters: For over 50 years, CRB has represented the highest level of professional achievement in brokerage management, according to the NAR. Having a broker’s license isn’t a requirement to earn the CRB designation, so real estate agents who are interested in learning the “business of real estate” may choose to earn the designation. Investors looking for a real estate agent or broker may benefit in choosing a CRB for a couple of reasons. First, only 3% of REALTORS® are CRBs, so the designation is for an elite group of industry leaders. Second, real estate practitioners holding the CRB designation have a median gross income 146% higher than non-CRB designees. This means that investors working with a CRB are represented by a top performer who knows how to find deals and get them closed.
Term: GRI
Definition: Gross Rental Income (GRI) is the amount of money collected in rent plus any additional income such as application fees, pet fees, parking fees, advance rent, or any expenses paid by the tenant to the landlord that are not required as part of the lease. Security deposits paid by the tenant are not considered to be income. Instead, refundable deposits are treated as a short-term liability on the balance sheet for the rental property because the deposit will eventually be returned to the tenant.
Why it matters: GRI is used by real estate investors to forecast the total amount of income a rental property could generate. When creating a property pro forma, investors begin with the GRI then make deductions for vacancy, credit loss, and bad debt to help determine how much adjusted gross income the investment will generate before paying the mortgage and normal operating expenses. GRI is also used by investors to calculate the GRM, or gross rent multiplier, of a property and by lenders when an investor is applying for a new loan or refinancing an existing mortgage, such as a cash out refinance.
Term: SFH
Definition: Single-family Home (SFH) is the most common type of rental property for real estate investors. An SFH is a free-standing house that is different from a townhome or apartment because it does not share walls or utilities with a neighboring property, and is located on its own parcel of land.
Why it matters: SFHs are the type of residential rental property investment that almost everyone is familiar with. For the investor, single-family homes are easy to find and finance, easier to manage and maintain than multifamily property, and easier to sell with multiple exit strategies when the time comes to sell. For tenants, renting an SFH is often much more desirable than living in a cramped townhome or condo with neighbors right next door. Because tenants usually place a higher value on living in a house, investors find that the property is normally better cared for by the tenant, with stronger cash flows due to higher rents and lower vacancy rates.
Term: HVAC
Definition: Heating, Ventilating, and Air Conditioning (HVAC) systems are used to heat and cool a house. Sometimes HVAC units have integrated heating and cooling systems, while other times the HVAC system of a rental property may consist of an air conditioning unit and a separate furnace unit. The ventilating part of an HVAC system is made up of ductwork that runs through the attic or crawl space under the floor, and the vents that allow air to flow into the individual rooms.
Why it matters: Even when investors use a local property management company, it’s important to understand how an HVAC system works and how they should be maintained. Conducting routine seasonal maintenance on an HVAC can help units last longer and reduce the risk of the air conditioning or heating going out at the worst possible time. In some tenant-friendly cities and states, property owners who don’t promptly address HVAC issues may be faced with fines or forced rent concessions. Performing regular maintenance on an HVAC includes replacing the inside air filter every three months, cleaning the condenser, and performing a semi-annual inspection to identify potential problems before they occur.
Term: GRM
Definition: Gross Rent Multiplier (GRM) is the ratio of the price of a rental property to its gross rental income before expenses. Another way of thinking about GRM is that the ratio represents how many years it would take for an investment to pay for itself based on the gross rental income received. Everything else being equal, the lower the GRM is the better the investment may be.
Example:
- Market value / Gross rental income = GRM
- $100,000 market value / $12,000 gross rental income = 8.33
Why it matters: GRM is a quick way of ranking potential rental property investments before spending time on a deeper analysis. Unlike Cap Rate, which measures the rate of annual return based on net income (excluding mortgage expense), the GRM is a multiplier that uses gross income. Investors buying and selling real estate can also use GRM to estimate property value. For example, if the GRM for similar rental properties in the market is 7.5 and the property generates a gross annual rental income of $15,000 then the property value should be $112,500 (GRM of 7.5 x gross annual rental income of $15,000). Or, if a single-family house has an asking price of $100,000 and the market GRM for comparable property is 8.3, the gross annual income from the home should be $12,048 ($100,000 market value / 8.3 GRM).
Term: PMI
Definition: Private Mortgage Insurance (PMI) is an extra insurance charged by lenders to borrowers making a down payment of less than 20%. PMI protects or insures the lenders in the event a borrower defaults, and usually costs between 0.5% and 1.0% of the total loan amount.
Example: $100,000 loan amount x 1.0% PMI fee = $1,000 per year or $83.33 per month in addition to principal, interest, taxes, and homeowner insurance
Why it matters: Borrowers who use an LTV higher than 80% are considered by lenders to be riskier than borrowers who can afford to make a bigger down payment. PMI is usually paid monthly, as part of the total PITI mortgage payment made to the lender. Once the loan balance reaches 78% LTV – in other words, when accrued equity in the property reaches 22% - a lender must terminate the PMI. If this doesn’t happen automatically, a borrower can contact their lender and ask for the PMI portion of the mortgage payment to be removed.
Term: REO
Definition: Real Estate Owned (REO) is property owned by the bank or lender that has already been foreclosed on but hasn’t been sold at auction. Many banks have REO departments whose job it is to get the property off of the bank’s balance sheet by selling it through a real estate agent who specializes in REO listings or through online platforms operated by FHA or HUD.
Why it matters: REO property can provide investors with a good opportunity to purchase a house at below market value. However, real estate owned property is sold by the lender “as-is, where-is” with only the most basic of warranties and no guarantees. REO houses are often in poor condition and may require a lot of repair work before they can be rented and generate cash flow. To increase the odds of getting an offer on a REO property accepted, investors should make strong offers with few or no contingencies and a large earnest money deposit to show the bank that they are serious about buying the REO home.
Term: CRE
Definition: Commercial Real Estate (CRE) is income-producing property that falls into the main categories of land, industrial, retail, office, special use (such as a gas station or government building), and larger multifamily apartment buildings. By contrast, Residential Real Estate includes property such as single-family homes, townhomes, condominiums and co-ops, and smaller multifamily property with two to four units.
Why it matters: Both commercial and residential property can generate cash flow and potential appreciation in market value to investors. However, unlike single-family houses, commercial property is more complicated to own and manage, more expensive to finance, and sometimes more difficult to sell. For example, an investor selling a house has multiple exit strategies available, by selling the property to another investor as a turnkey rental or by selling to an owner-occupant. CRE is usually bought and sold by well capitalized sophisticated investors such as private equity firms or hedge funds, making it much more difficult for a smaller investor to compete.
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This is a growing list and we’ll continue to add to it! If you have a real estate investment term you’d like us to address, be sure to let us know in the comments or Tweet us @Roofstock.
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