Return on Investment (ROI)

ROI is a generic term often referenced in investing. It is a percentage of how much money you’re making, and it depends on a number of variables. There is more nuance to ROI than you’d expect, so we’ll discuss some specific types of ROI.

Cash-on-Cash ROI (CoC ROI or Cash-on-Cash Yield)

CoC ROI is an extremely common metric in investing. It is essentially “bank account ROI,” meaning that if you invest $100K and see $10K of cash flow (i.e. cash returning to your original bank account) over the first year, you earned a 10% CoC ROI. It’s what most investors care about because it tells you how much cash you are receiving.

Cash-on-Cash ROI = Annual Net Cash Flow / Invested Equity

Annualized ROI

Another way that investors will compare returns is by annualized ROI, which means looking at the return on a yearly basis. If I offer you a deal where you’ll make a 90% ROI, it may sound like a great deal, but the timeframe plays a big role. What if that 90% ROI is made over the course of ten years? It’s not such a great deal now. What about over the course of ten months? Now that’s a much more solid return! The annualized ROI will either average longer term (i.e. multi-year) investments or expand short term investments to a yearly basis.

Annualized ROI = ((P + G) / P) ^ (365 / n) – 1

Where P is your initial investment or principal, G is your losses or gains in the investment, and n is the number of days invested.

Instantaneous ROI

“How much money will I make on this deal?” Well, it depends! If you want to know your ROI at the end of an investment versus at the beginning (again, without referencing how long that investment lasted), you can calculate the instantaneous ROI.

Instantaneous ROI = (P + G)/G – 1

Where P is your initial investment or principal and G is your losses or gains in the investment.

Equity Multiplier

An Equity Multiplier is another way to show instantaneous ROI, showing it not as a percentage but as a number. For example, if you invest $100K and make $75K in cash flow (plus you get your original $100K principal back), you would then have $175K in your bank account; your equity multiplier would be 1.75x. It’s the same formula as Instantaneous ROI, except you are not identifying the value as a percentage here (i.e. you’d normally multiply the previous ROI calculations by 100 to get the percentage values). Remember, it does not contain a time component, so by itself the Equity Multiplier may not give you all you need to know about an investment.

Equity Multiplier = (P + G)/G – 1

Where P is your initial investment or principal and G is your losses or gains in the investment.

Gross Rental Income (GRI)

This term refers to how much you actually collect in rental income.

Gross Yield

This term is another one used to compare properties at a basic level to weed out the bad deals quickly. It compares how much income a property can produce compared to its value. I use this method to filter a list of potential short-term rental properties to determine which I’ll analyze more deeply. I like to see a minimum of a 10% Gross Yield (i.e. If I buy a property for $500K, I want it to make at least $50K per year in gross rent).

Gross Yield = GRI/Property Price

Gross Rent Multiplier (GRM)

This calculation is essentially the opposite of Gross Yield. Where a higher number in Gross Yield is better, a lower GRM indicates a higher potential for larger returns. For example, I like to see a maximum of GRM of ten.

GRM = Property Price/GRI

Potential Gross Income (PGI or Scheduled Income)

PGI is how much a property could make if it were performing at maximum level in the market (i.e. all units being charged full market rent). It’s the pie-in-the-sky number that you shoot for in performance.

Physical Vacancy

This term tells you how much income you’re not earning due to not having tenants in your properties. It can be shown as a percentage (as a vacancy rate) or a dollar amount (as a vacancy expense). For example, if I have a ten-unit apartment complex, but one of my units is vacant, I have a 10% vacancy rate. If I could charge $1K for that unit, the vacancy expense is $1K––it’s an expense on my financial statement because it’s a missed revenue opportunity. For single-family residential (SFR) and long-term rentals (LTR), I often budget for an 8% vacancy rate, which equates to my property being vacant one month out of each year.Lorem ipsum dolor sit amet, consectetur adipiscing elit?

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Economic Vacancy

Economic Vacancy accounts for the loss to the potential income of a unit compared to market rent if you have a tenant in place. There are three main types.

Concessions

These are a special promotion given to a tenant in exchange for something else of value to you. For example, I might allow a police officer to live in my apartment complex at a discounted rate because I want their squad car present for safety. If my market rent for a unit is $1,200/month and I charge the officer only $700/month, I would have a $500 Economic Vacancy expense.

Bad Debt

This occurs when tenants are behind on rent or fees owed.

Loss to Lease

This is the difference between the market lease rate and your current tenant leases. If I have ten units leased at $900/month but the market rent has increased to $1K/month, I’m showing a Loss to Lease of $1K/month total (i.e. $100/unit).

Additional Income / Other Income

These forms of income are the additional means of making money outside of rent. Some common examples include laundry service, pet fees, or RUBS (see below).

Effective Gross Income (EGI)

When you calculate EGI, you start to see more realistic numbers in your calculations as opposed to those pie-in-the-sky numbers in the PGI. To determine the EGI, you take the PGI plus any additional income and then subtract both the inevitable physical and economic vacancies.

EGI = PGI + Additional Income – Physical Vacancy – Economic Vacancy

(Normal) Expenses

Think of Expenses as your regular monthly bills, such as management fees, utilities, basic maintenance (i.e. fixing leaking toilets, repairing HVAC units, etc.), regular contractor fees (i.e. lawn care, pest control, etc.), administrative costs, payroll, insurance, taxes, etc. These expenses do not include your debt service and CapEx (see below).

Net Operating Income (NOI)

NOI is a significant variable in the investor world, especially in commercial real estate where it’s discussed ad nauseam. If you were to buy a property with cash and not consider CapEx (see below), NOI would be your cash flow. Simply put, NOI is income minus expenses; to be more specific, NOI is your EGI minus your (Normal) Expenses.

NOI = EGI – Expenses

Debt Service

This term refers to how much you pay for any debt on the property. Usually, it’s the principal and interest owed to the bank, but it could also be money owed to a private lender, hard money lender, or another lending outlet that has a mortgage on your property. Sometimes, debt service will be interest-only payments, with the principal on the loan not being paid down for the first couple of months or years of ownership.

Capital Expenditures (CapEx)

CapEx is the cost for repairs to or replacement of substantial items on your property that are not handled on a regular basis. Some examples include roof replacements, HVAC replacements, repaving roads at a Mobile Home/RV park, large renovation projects, foundation repairs, etc. There can be a gray area as to what counts as CapEx and as Normal Expenses, but it is important to separate the two as much as possible, especially in the commercial space, because adding additional expenses will reduce your NOI, which will reduce the value of your property. There are also tax implications between categorizing something as a Normal Expense versus CapEx.

Replacement Reserves or CapEx Reserves

These terms refer to funds set aside to cover large CapEx items that you expect to happen in the future. Usually, you set aside a small amount each month. For example, if you expect the roof on a property to need replacement in ten years and estimate the cost to be $12K, you will try to save $1K/year (or $84/month) for if/when that roof needs to be replaced.

Cash Flow

In REI, you’ll often hear the phrase, “Cash flow is king.” And Cash Flow is just what it sounds like it is: the flow of cash at the end of each month or year. It is different from NOI in that it considers Debt Service, Capital Expenditures, and Replacement Reserves.

Cash Flow = NOI –­ Debt Service – CapEx – Replacement Reserves

Working Capital

Working Capital is simply your current assets minus current liabilities. By “current,” I mean as expected over the next twelve months. Whereas Cash Flow tells us how much cash your investment can make over time, Working Capital is a snapshot of your investment’s financial health now.

Investment Reserves

If your investment stops producing income, the amount of time before you will be out of money is determined by your Investment Reserves. Sometimes lenders will require a certain level of reserves to be set aside at closing. This calculation will vary from investor to investor, but common reserve levels are three, six, and twelve months––meaning that you have enough saved up to weather the storm for that amount of time if your EGI went to $0.

Net Present Value (NPV)

While not commonly discussed in REI, NPV is an important concept to understand. Say I have two investment opportunities. In Opportunity #1, I lend you $100K, and you pay me back $125K in one year. In the Opportunity #2, I lend you $100K, and you pay me back $125K in five years. The first opportunity will be much more exciting to me. Why? Because time affects the value of money. NPV accounts for that time-value of money.

In my examples, to decide whether or not to invest, I would need to consider how much my current cash of $100K will be worth in the future by using an assumed rate of return (also known as a discount rate). I won’t get into the actual mathematical formula for calculating NPV because it’s unnecessarily complex for this discussion, but you can search for it online if you are that curious.

Let’s say I’m confident that I can grow my current $100K at a 9% annual rate of return. In one year, under normal or expected conditions, I can expect to turn that $100K into $109K.

Opportunity #1

($125K in one year), when discounted at my 9% annual rate, results in an NPV of about +$14,600.

Opportunity #2

($125K in five years), when discounted at my 9% annual rate, results in an NPV of about –$18,700.

Basically, the NPV of +$14,600 represents the intrinsic value of investing in Opportunity #1 compared to my assumed rate of return under normal conditions where I expect a 9% growth. The NPV of –$18,700 represents the intrinsic loss of investing in Opportunity #2 compared to that assumed rate of return––in other words, I’d be better off holding onto my money and letting it grow where it is rather than investing in Opportunity #2.

Make sense? Remember, in the big picture, time always affects the value of money!

Internal Rate of Return (IRR)

IRR is a metric used more often than NPV. IRR is the rate of return at which the NPV of an investment equals zero. The usefulness of IRR is its ability to represent an investment opportunity’s possible return so you can compare it with other opportunities. IRR also takes into account the time value of money––the speed at which you will get your money back––so it’s not nearly as simple as Annualized Return.

For example, let’s compare two investment opportunities.

Opportunity #1

You can invest $100K into a syndication. You can expect to earn $10K/year for five years and then get your original investment of $100K back in year five when the property is sold. Thus you can expect to have $150K total in five years.

Opportunity #2

You can invest $100K in a syndication. You can expect to earn $8K in year one, $100K in year two due to an expected cash out refinance, and $8K in years three through five. Thus you can expect to have $132K total in five years.

Which investment yields a higher return based on the time value of your money? You can answer this question by determining the IRR of each investment. (Again, I won’t go into the formula itself, but you can find it online.) The IRR of Opportunity #1 is 10.0%. The IRR of Opportunity #2 is 13.1%. The big payout in year two of Opportunity #2 is the crucial difference because the sooner you get your money back, the sooner you can reinvest it and grow it more. Thus, Opportunity #2 offers you more chances to grow your wealth when considering the time value of money.

Clear as mud? Basically, IRR is a metric commonly used to compare investment opportunities because returns aren’t always as consistent and straightforward as we’d like them to be.

C-Suite

I had to google this term when I started dealing with wealthier clients, so this will hopefully save you the effort. The C-Suite refers to the executive-level managers of a company, like CEO (Chief Executive Officer), CFO (Chief Financial Officer), CTO (Chief Technology Officer), etc. All the “chiefs” are the C-Suite.

Syndication

A real estate syndication is a way for multiple investors to pool their money and resources together to purchase a larger real estate investment than they could on their own.

This is typically done through a limited liability company (LLC) or limited partnership (LP) structure. The syndication is led by a sponsor, who is responsible for finding the deal, managing the investment, and providing returns to the investors. In exchange for their investment, the investors receive ownership in the LLC or LP and a share of the profits from the investment. This allows investors to diversify their portfolio, participate in larger deals, and benefit from the knowledge and experience of the sponsor. It’s a powerful tool for those looking to grow their wealth through real estate investment.

A great example of this concept is when a group of investors bought the Empire State Building in the 1960s. Some people invested as little as $10,000 to be part-owners of the $65M property.

Real Estate Investment Trust (REIT)

A REIT is a publicly traded company that owns and operates income-producing real estate properties. Unlike with a syndication, you can cash in and cash out quickly with a REIT, just like you’d buy and sell stocks. The owners of the Empire State Building, because it was doing so well, eventually transitioned their syndication into a REIT, which then effectively allowed anyone to invest in it on the stock market.

General Partner/ Limited Partner (GP/LP) vs Sponsor/Investor

Syndication deals are created and run by a Sponsor (also sometimes referred to as the syndicator, operator, asset manager, or General Partner (GP)). A sponsor can be either an individual or company. The sponsor finds an opportunity, raises the capital, executes the acquisition, and is responsible for the day-to-day operations. The investors (also sometimes called Limited Partners (LP)) are passive players in the syndication game. They typically don’t bear the legal liability that the sponsors do and are not involved in the day-to-day operations. The investors will often get status updates and disbursements from the cash flow of the investment, as determined by their ownership percentage and the subscription agreement of the syndication.

Regulation D Offering (Reg D)

This term refers to the typical type of offering that syndicators use. Reg D is part of the U.S. Code of Federal Regulations that allows these syndications to be exempt from filing with the Securities and Exchange Commission (SEC), as opposed to publicly traded companies.

Sophisticated vs Accredited Investors

A Sophisticated Investor is someone who understands that there are winners and losers when it comes to investing, and that there are always risks and never any guarantees in any investment opportunity.

An Accredited Investor is someone who has a specific amount of money that they have made, whether in stock holdings, cash, or another form—it’s also called their net worth.

There are specific guidelines in every syndication, such as that an accredited investor must have made $200,000 over the past two years.

506B versus 506C Offering—(Under Reg D)

Sophisticated investors and accredited investors are both allowed to invest in 506B offerings. These offerings cannot be advertised publicly, so they work best with investors with whom you have a preexisting relationship. Only accredited investors are allowed to invest in 506B offerings. These offerings can be advertised publicly.

Syndication Documents

The first time you consider a real estate syndication can definitely be confusing and a bit scary. There are four main documents to review and sign:

Private Placement Memorandum (PPM)

The PPM is the main disclosure that describes the structure of the syndication entity (typically an LLC or Limited Partnership (LP)). The PPM will describe the risks involved in the syndication and how it’s not a traditional liquid investment like the stock market.

Operating or Partnership Agreement

This document will discuss things like duties of the sponsors and investors, voting rights, bylaws, etc.

Subscription Agreement

In this document, an investor will certify that they meet the requirements of the 506B or 506C syndication and explain how much they plan to invest in the opportunity.

Business Plan or Investor Pitch Deck

This document describes the details of the investment itself as well as future projections. The pitch deck is normally presented to investors in some form when the investment offering begins. Webinars are a common tool used to disseminate this information quickly.

Profit and Loss Statement (P&L)

The P&L is simply the financial statement that shows the income and expenses. Your ability to read a P&L (or at least generally understand it) will be very helpful when analyzing investment opportunities.

Trailing Three or Twelve Months (T3 or T12)

Looking back at a property’s historical performance is an important aspect in deal analysis, so you’ll often see investors request the Trailing Twelve Months of financial statements (or T12). To try to get a more accurate measure of recent income trends and also long-term expense trends, it’s very common to take the T3 income, annualize it (i.e. take the average and multiply it by twelve months), and then subtract the T12 expenses to calculate a conservative estimate of the NOI, which is an important variable in determining value.

Debt Coverage Ratio (DCR) or Debt Service Coverage Ratio (DSCR)

These terms, which are used interchangeably, both refer to a metric of an investment’s net operating income (NOI) versus its debt obligation (i.e. interest and/or principal paybacks to the bank or any lenders to whom you owe money). DSCR gives the lenders a metric of how healthy an investment is and how much buffer a borrower has to pay back their debts after paying their expenses. Lenders will often want to see a DSCR of at least 1.25. [DSCR = NOI/Total Debt Service]

Rent Roll

The rent roll is an itemized report of each unit in any sort of income-producing property. It shows who is occupying each unit (or if a unit is vacant), payment history, security deposits, how long the tenant has been in place (along with their lease expiration date), etc. After an investor gets a deal under contract, it’s important for them to verify that the rent roll they received as part of their initial due diligence is accurate. For example, if the rent roll says Sally Smith lives in unit 8A, but during inspection an investor finds that unit 8A is vacant, they are looking at a discrepancy that will affect their bottom line.

Ratio Utility Billing System (RUBS)

Not all investment properties are sub-metered, meaning each tenant may not have their own water and/or electricity meter. When a property is “master metered,” meaning it has a single meter for all tenants, a cost-effective way to have the tenants pay for utilities is through a RUBS. To create this system, the owner splits up the utility bill so that everyone pays a fair share. The fair share can be based on all sorts of variables such as number of bedrooms, square footage, number of occupants, etc. It’s rare that owners will split up 100% of the utility bill and important that they don’t make a profit from a RUBS. Otherwise, they are acting as a utility company and subject to additional oversight and regulations.

Capitalization Rate (Cap Rate)

To determine value in commercial real estate, you cannot simply look at comparable sales (which is the common method for determining value in residential real estate) because there are too many differences between one property and another. Instead, value in commercial real estate is determined by how much money a property can produce (i.e. a property’s Net Operating Income (NOI)). Cap Rates are the metric used to compare commercial property values within a metropolitan statistical area (MSA) by looking at known sale prices and their respective NOIs. Simply put, it’s just the NOI divided by the value.

Cap Rate = NOI/Value

In practice, you use the Cap Rate of one property to determine the value of another. If you know that Apartment Complex A has 100 medium-sized units, recently sold for $10M, and made $600K in NOI last year, you determine the Cap Rate is 6% by using the formula above.

You can now apply that Cap Rate to Apartment Complex B, which you are considering purchasing. It has 65 nice, medium-sized units and made $500K last year. You use the formula of Value = NOI/Cap Rate and determine its value is $8.3M.

Basically, the Cap Rate is the ‘going rate’ in the area, and it’s a way to make reasonable comparisons. It’s also worth noting that when Cap Rates go down, property values go up.

Acquisition Fee/Asset Management Fee/Capital Transaction Fee

These fees are three common types you’ll see on syndication deals.

Acquisition Fee

This is a percentage of the purchase price that is paid to the sponsor (or GP) for getting the deal set up and executed. Common acquisition fees range from 1–2%.

Asset Management Fee

This is an ongoing fee to the sponsor for their work managing the asset (i.e. the property purchased through the syndication); the asset management fee is separate from the property management fee because the sponsor is generally managing the bigger picture. I like to say that the asset manager manages the property managers—it’s a lot of management, but it’s an important role to a successful syndication. Asset management fees normally range from 1–5%.

Capital Transaction Fee

This is a fee paid to the sponsor upon the sale of the property as a reward or payment for their hard work in getting the sale to happen when you complete an investment opportunity. I normally do not charge a capital transaction fee as a syndicator, but when people do charge them, 1–2% of the sale price is a normal range.

Preferred Return (Pref)

When discussing investment opportunities with LPs or investors in our syndications, we cannot guarantee any returns. By nature of an investment, anything can happen to an investor’s money, and we cannot ensure they will make any money back at all. To create confidence in a deal, however, we can offer a Pref, where we promise that all extra cash flow will go to our investors first until they are paid this preferred return.

For example, let’s say you invested $120,000 into a syndication with a 10% preferred return; that percentage breaks down to a $12,000 pref per year (or $1,000/month or $3,000/quarter). In this example, the distributions are paid quarterly to the investors. Let’s say that based on your investment and LP ownership percentage, there is enough cash flow to pay out $4,000 in the first quarter. The first $3,000 would go to you to cover your pref, and, typically, the remaining $1,000 would be split between the LP and GP based on their ownership percentages.

What happens if the preferred return isn’t covered? Most syndications will offer a cumulative (but not compounding) return structure. So, for the example above, if the cash flow only paid for $2,000 in that first quarter to the investor, they would be owed an additional $1,000 in the following quarter on top of the expected $3,000 (i.e., a total of $4,000) to ensure that all cash flow goes to them until they hit that minimum pref of 10% annually.

Waterfall Payment Structure (Waterfall)

Here is where returns between sponsors and investors can get complicated. In a waterfall, the cash flow splits change based on the amount of capital that is paid back to the investor.

For example, let’s say a waterfall offers a preferred return of 6%, followed by a 70/30 split based on partnership status (LP/GP %) for a 6–8% return, a 50/50 split for an 8–10% return, and a 30/70 split above a 10% return. This structure incentivizes the sponsor to perform as strongly as possible; the higher return the sponsor pays the investor, the larger the payday for the sponsor.

I’m definitely a fan of the KISS method—Keep It Simple, Stupid!—so if I use a waterfall structure in my syndications, I try to keep it as simple as possible. (A confused mind tends to answer any offer with a “no,” so I try to not confuse my investors so I have a chance of getting a “yes”! )

Depreciation vs Appreciation

As real estate agents, we understand the concept of appreciation. Generally, we like to see broad and continual appreciation of the market and our clients’ home values. However, one massive benefit to owning investment real estate is that the IRS allows you to view that purchase as a depreciating asset from the moment you buy it.

Just as a car loses value the moment you drive it off the car dealership lot, the IRS allows us to view our investment properties the same way.

Per IRS Publication 527, commercial real estate depreciates over a period of thirty-nine years while residential property (which includes multifamily properties) depreciates over twenty-seven and a half years. After those time periods, the properties cannot depreciate any more (i.e. their depreciation basis is $0).

Keep in mind, however, that the actual land does not depreciate––dirt is dirt is dirt. It’s the improvements on the land that depreciate. These improvements are of course buildings, roads, sewer systems, etc.

How does depreciation help you as a rental property owner? As an example: If you had $10K/year in depreciation, it is basically a paper-only expense. If that property produces $12K of taxable income in a year, you can effectively subtract the depreciation expense to reduce your tax burden. In this example, you’d subtract your $10K in depreciation from the $12K in taxable income, which would result in you only having to pay taxes on $2K of rental income. Obviously, there are more variables to consider in terms of write-offs and taxes, but this is a simple way to see how depreciation can save you money in the near term!

It’s worth noting that this isn’t a free gift from Uncle Sam. When you go to sell your property that has been depreciated, you’ll have to consider depreciation recapture, but we’ll discuss that topic another time!

Cost Segregation Study (Cost Seg)

While the depreciation previously discussed is one of the benefits of owning rental property in the United States, a Cost Seg really allows you to maximize that benefit! A cost segregation study involves segregating––or separating out––individual components in a property when calculating its depreciation.

To do a Cost Seg on a rental house, you would typically pay a specialist to come to the property and identify all its components based on their lifespans. For example, the flooring in a property may not have that lifespan of twenty-seven and a half years that the IRS uses to determine depreciation for the entire house––its lifespan may be just five years.

By separating out the lifespans of the different items, you’re able to depreciate those individual items even faster and enjoy more tax savings now. The current tax code even allows for bonus depreciation, which allows us to accelerate a certain percentage of the items with a twenty-year lifespan or less into the first year for huge savings.

My clients and I have deferred hundreds of thousands of dollars by leveraging cost segregation studies and accelerating depreciation. It is the government’s way of incentivizing real estate investors to spend investment dollars on housing and real estate in America. These few paragraphs barely scratch the surface on this topic, so I highly recommend spending the time to understand this topic!

De Minimis Safe Harbor

The IRS defines this term as “an administrative convenience that generally allows you to elect to deduct small-dollar expenditures for the acquisition or production of property that otherwise must be capitalized under the general rules.” Stated more clearly, a De Minimis Safe Harbor allows you to add items as an expense rather than capitalize that purchase on items of $2,500 (or in some cases $5,000). It’s a way to save on taxes in the near term rather than waiting on the depreciation savings down the road.

Proforma

A proforma is the projection of how an investment is expected to work out in the future. It lists the expected future incomes, expenses, assumptions, NOI, etc.—the variables by which most investors will decide if an investment is an opportunity that they would like to pursue.

Low Income Housing Tax Credit (LIHTC)

The LIHTC is a federal and state program that provides a tax incentive to build and/or rehabilitate affordable rental housing for low-income households. It’s another program that highlights the tax benefits of investing in real estate.

Class A/B/C/D Properties and Areas

This classification system is a way to label the quality of a property or area. It gives investors a general understanding of a property or area but, due to its subjectivity, it’s a limited system. For example, a class A apartment complex would be one that is in great shape with a lot of amenities such as a pool, gym or even coffee shop on-site. A class B complex would be one that is nice with few amenities. A class C complex would be one that is safe and clean without any extras. A class D complex would be one that is inadequate in most or every way. Area classifications are similar: a class A area would have a lot of wealth, high-quality homes, great schools, amenities, and restaurants. A class B area would have good homes and schools but not as many home-owners associations (HOAs) or amenities. Class C would have a lot of lower-middle class housing, no HOAS, yards that are not always kept up, and only passable schools. Class D or section 8 housing areas would be undesirable in most ways.

Earnings Before Interest, Taxes, Depreciation, and Amortization (EBDITA)

This metric measures the profitability of a company. Some investors will use this term synonymously with the Net Operating Income of a real estate property.

Wholesaling vs Flipping

I think most people understand what a house flipper does. They buy properties under market value, fix them up, and then sell them. Wholesalers flip contracts rather than houses. In a nutshell, they get a property under contract and then they assign that contract to an end buyer for a fee. It’s great to have a solid network of both wholesalers and flippers as an investor-agent.

Wholetailing

This is an amalgamation of flipping and wholesaling. Wholesaling (combining wholesaling with a retail sale) is when a wholesaler actually closes on a property (rather than assigning the contract) and immediately posts that property for sale on the MLS with very little or no rehab work at all.

After Repair Value (ARV)

This is an incredibly common term for flippers. The ARV is the estimated amount that a flipper will sell the property after the rehab is completed. There are plenty of techniques to determine an ARV, but it’s essentially a future-forecasted CMA.

Buyers List

Most wholesalers and flippers have a list of buyers that they are looking to grow. For wholesalers, this is the list of people to whom they’re trying to assign these contracts that they have. I recommend getting on as many of those lists as possible. At most investment meetups if there are wholesalers around, they’ll typically advertise for people to sign up on their list. Sure, you’ll see plenty of deals that you aren’t interested in, but you may find some hidden gems.

Off Market Deal

An off market deal is simply any deal that is sold that’s not part of the MLS or publicly advertised on some mass medium. As an investor-agent, you’ll need to become the master of finding and providing off market deals for your investor clients. These deals could come from wholesalers, pocket listings from other agents, online forums of owners/investors, etc.

Distressed Property/Motivated Seller

This is the seller that most flippers and wholesalers are seeking and is effectively anyone who is in a position that they either must sell their property or just really want to sell. This could be people who are behind on taxes, going through divorce, someone who recently inherited a property that they don’t want, a disgruntled landlord, etc. The list could go on and on.

List Stacking

This is a technique to try to find the sellers with the highest motivation. Rather than just targeting a list of people who have back owed taxes, an investor will also pull the lists for something like people going through a divorce and another list of people who are behind on their water bill. After they have multiple lists of people with potential motivation to sell, they’ll ‘stack’ the list and try to find the people that are on every one of the lists. If someone is going through a divorce, behind on their taxes, and late on their water bill, there’s a good chance that they will want to sell their property. These are just examples, but you can imagine there are plenty of possibilities when it comes to list stacking.

Subject-To (Sub2)

This is when a buyer purchases a property from a seller (i.e. the deed is transferred officially) but the seller’s mortgage is not paid off at closing. The buyer takes over payments on the mortgage, or he buys it ‘subject-to’ the seller’s mortgage. The loan is not assumed, so the seller’s name remains on the mortgage. There are plenty of nuances to consider when executing a sub2 deal, so I suggest working with an investor or title attorney who has executed one if it’s your first time!

Holding Fees / Carrying Costs

During a fix & flip renovation or rehab project, any fees outside of the actual rehab itself are effectively the holding costs. This consists of things like utility bills, debt payments, insurance costs, property taxes, etc. Holding costs can become a large factor in the analysis during a slow market or an extensive rehab that will take a while to complete.

Driving for Dollars

Driving for dollars is a super popular technique for wholesalers and flippers to essentially drive around their target areas to identify properties with potential motivated sellers. They look for properties with overgrown hedges, notices on doors, etc., and then will track down the seller to see if they can make a deal happen.

Ringless Voicemail (RVM)

The laws regarding ringless voicemails or RVM, along with mass texting, continue to change, so I always recommend that you check the current state and federal guidelines; regardless, RVM is when a voicemail is dropped into someone’s phone without the phone ringing at all. It can be an effective tool in certain drip campaigns and is used by some investors to target their various motivated seller lists.

Bandit Signs

Everyone has seen the little signs by the side of the road or taped to telephone poles that say “I Buy Houses Cash” – Those are bandit signs. While they may seem rudimentary, you continue to see them everywhere because they continue to be a cheap and effective marketing tool for flippers and wholesalers.

Joint Venture (JV)

A joint venture is when two or more parties collaborate together to tackle some sort of an investment deal. It’s a simple way of partnering with another investor to make a deal happen that you could not make happen by yourself.

Double Close

A double close is when a wholesaler closes on the property that they are buying and immediately closes with the end buyer. This is common when wholesalers are making a very large assignment fee that they may not want the end buyer to see at closing. Because it is two closings, there are double the closing costs involved, and transactional funding will typically be used (i.e. very short term, high interest lending), so be sure to consider all variables in a double closing.

BRRRR Technique

This is an investment strategy coined by Brandon Turner (previous BiggerPockets podcast host), where an investor Buys, Rehabs, Rents, Refinances, and then Repeats the process – It’s a solid technique for being able to reuse the same funds for multiple investments. A quick and simple example to illustrate the technique:

You buy a house for $100K cash and then rehab the property for an additional $40K. After the rehab, you rent the property for $2,000/month.

Now that you have a cash flowing, updated rental property, you refinance the property at a 70% LTV, which results in a $140K refinance.

You now get a check for $140K (i.e. you get all of your money back), and you keep the cash flowing rental that was just fixed up. You can go use that same cash to repeat this process on another property.

The BRRRR technique is very popular amongst investors. My caution to anyone pursuing a full BRRRR strategy is to avoid over-leveraging and ensure that they have adequate financial reserves for each of their investments.

70% Rule of Thumb (ROT)

Sometimes called the 75% ROT, this is a technique for flippers and wholesalers to quickly assess whether a deal is worth pursuing or not.

The formula is (70% x ARV) – Rehab Cost = Max Allowable Offer

As an example, if there is a property that you think you could sell for $300K after an estimated $50K rehab:

(70% x $300K) – $50K = $160K

In this example if you could acquire the property for $160K or less, it may be a deal worth pursuing.

While it’s an effective and quick technique to assess the validity of a deal, all investors should back up their analysis by actually breaking down all of the costs of the investment from start to finish.

Loan to Value (LTV)

The LTV of a loan is the ratio of the loan amount to the value of the property. For example, a loan with a 75% LTV on a $400K property would result in a $300K mortgage.

LTV = Loan Amount / Property Value

Loan to Cost (LTC)

The LTC on the other hand is the ratio of the loan amount to the total project cost, and is typically used in a commercial or construction lending situation. The Total Project Cost Includes acquisition costs, construction costs, and development costs. For example, if you buy the land for $100K, and it’ll cost $100K to develop and construct, an 80% LTC loan would be $160K.

LTC = Loan Amount / Total Project Cost

Hard Money Loan / Private Money Loan

There are plenty of ways to finance creative real estate deals, but hard money and private money are very popular ways of making deals happen.

Hard money is normally called ‘hard’ because it is secured to a hard asset and the interest rates/terms can be hard to accept compared to conventional purchases. Hard money is typically loaned through an organized group of investors or an online outlet, such as Kiavi or Finance of America. Hard money lenders are typically willing to lend on deals that conventional loan originators won’t touch. Hard money is most popular amongst flippers, who can sometimes find hard money lenders that will even offer 100% of the acquisition and 100% of the rehab amount.

Private money lenders are a much more flexible outlet for lending. Simplistically, a private money lender is anyone outside of a bank or hard money lender that is lending money to an investor. This could be in the form of your grandma lending you money or another investor you know lending toward a deal that you are trying to tackle. The terms of private money are completely up to the two parties. Private money is sometimes secured on the assets, and other times it’s a completely unsecured promissory note. Really, the possibilities are endless with private money.

Most investors don’t openly share their private money lenders because it’s typically a very personal relationship.

Seller Carryback/Owner financing

A seller carryback deal is when there is owner-provided financing at closing. The seller effectively acts as the bank and carries a mortgage on the property, collecting monthly payments from the buyer.

Amortization

This is the period in which a loan is paid off by regular payments. Realize that this is separate and distinct from the term of the loan.

Term of Loan (Balloon Payment)

The term of a loan is when the entire loan must be paid back. There are often times in creative financing or commercial loans that a loan will be amortized for a much longer period of time than the term, so a large payment (known as a balloon payment) will be due at the end of the term.

DSCR Loan

A DSCR Loan (Debt Service Coverage Ratio Loan) refers to a loan where the lender evaluates the eligibility based on the property’s Debt Service Coverage Ratio. This ratio measures the income available to pay the debt. It is calculated by dividing the property’s annual net operating income (NOI) by its annual debt service. Lenders use this ratio to assess the property’s ability to generate enough income to cover the loan payments, making it an important factor for investment property loans. A higher DSCR indicates a greater ability of the property to cover the debt, thus increasing the likelihood of loan approval. A DSCR for a typical loan approval would be between 1.25 – 1.35.

DSCR = NOI / Debt Service

Interest Only (I/O Period)

Depending on the investment strategy, investors may ask their lender for a certain interest only period to maximize cash flow, maximize near-term DSCR, minimize monthly debt payments, or a myriad of reasons to want interest-only payments. The benefit is a reduced monthly payment, and the downside is that your loan principal isn’t reduced.

Warrantable versus Non-warrantable Condo

The distinction between a warrantable and non-warrantable condo is important mainly for financing purposes.

Warrantable Condo:

A warrantable condo meets specific requirements set by government-sponsored enterprises like Fannie Mae and Freddie Mac. These standards typically include factors like the percentage of owner-occupied units, no single entity owning a majority of the units, the financial health of the condo association, and the level of commercial space in the building. Warrantable condos are considered less risky for lenders, making it easier for buyers to secure financing, often with better loan terms.

Non-Warrantable Condo:

A non-warrantable condo does not meet these criteria. Reasons might include a high number of units being rented out, one entity owning multiple units, or the condo association’s budget not meeting certain criteria. Since these properties are viewed as riskier investments, they are more challenging to finance. Lenders that do offer loans for non-warrantable condos typically do so with higher interest rates and larger down payments.

Secondary Market

This is where existing home loans and mortgage-backed securities are bought and sold. After a mortgage is originated by a lender in the primary market, it can be sold in the secondary market, often to government-sponsored enterprises like Fannie Mae and Freddie Mac. This process helps lenders free up capital to make more loans.

Portfolio vs Conventional Loan

Portfolio Loan:

This is a type of loan that a lender keeps in its own portfolio and does not sell on the secondary market. These loans are often held by the originating bank or financial institution and may not conform to the standards set by government-sponsored enterprises. They offer more flexibility in terms and underwriting standards.

Conventional Loan:

A conventional loan conforms to the standards set by Fannie Mae and Freddie Mac and is eligible to be sold on the secondary market. These loans typically have stricter qualifying criteria but often come with more favorable interest rates.

Delayed Financing

This is a financial strategy where an investor purchases a property with cash and then shortly afterwards takes out a mortgage on that property. The goal is to immediately regain most of the cash spent on the purchase. Delayed financing can be used to secure properties quickly in competitive markets or to invest in properties that might not initially qualify for financing.

Novation Agreement – Flip and Flip Strategy (not long term hold)

In a flip and flip strategy, which involves quickly buying, renovating, and selling a property for profit (not holding it long-term), a novation agreement might be used. This legal document transfers one party’s rights and obligations under a contract to a third party. In the context of real estate flipping, it might be used, for example, to transfer the original purchase agreement to a new buyer, allowing the flipper to sell the property before they officially own it. However, this strategy is quite specialized and may not be commonly used or widely recognized in standard real estate practices.

Long Term Rental (LTR) vs Short Term Rental (STR)

Think about renting out your place. If you’re looking for tenants who’ll call your property home for a year or more, you’re in the LTR camp. But if you’re imagining a revolving door of guests staying for a few days or weeks, much like a vacation spot, you’re playing the STR game. Both have their perks: LTR offers stability, while STR can mean higher income.

The exact legal difference between an LTR and STR will vary depending on the area, but six months is often the delineator.

Turnkey vs Value-Add Investing

Turnkey Investing: This approach involves purchasing investment properties that are already renovated, often with tenants in place, and require minimal immediate maintenance or upgrades. These properties are typically managed by a property management company, making them ideal for investors looking for a hands-off approach.

Value-Add Investing: This strategy focuses on acquiring properties that need significant improvements or renovations. The investor adds value through these upgrades, aiming to increase the property’s rental income potential and resale value. This approach often requires a more active role in management and a deeper understanding of real estate renovation.

Note Investing

Forget bricks and mortar for a second. Imagine investing in the debt that’s secured by real estate, like mortgages. That’s Note Investing. You’re basically stepping into a bank’s shoes, earning money from interest. It’s a different ball game, with its own set of rules, but can be a lucrative way to diversify your real estate portfolio.

Tax Lien Investing

Have you ever thought about what happens when someone doesn’t pay their property taxes? The government will typically slap a tax lien on the property, and here’s where it gets interesting for investors. Oftentimes, local governments will sell these liens to investors. Why? Because they want their money now. When you buy a tax lien, you’re essentially paying those owed taxes. In return, the property owner owes you the tax amount along with some (often) heavy interest. 

If the owner can’t pay the debt owed, you have the ability to possibly take ownership. It’s a different way to play the real estate game, with its own set of risks and rewards. Before diving in, do your homework, but remember: where there’s risk, there’s often opportunity!

Rental Analyzer or Rental Calculator

Before diving into a deal, using a tool like a rental calculator can be your best friend, helping to separate the gems from the duds. There are plenty of calculators to choose from online, and many investors just create their own in Google Sheets or Excel.  One of the more popular calculators that I’ve used is part of the BiggerPockets website. 

Enemy Method

The Enemy Method in Airbnb investing refers to using the performance of your “enemies” to estimate the revenue, ADR, and occupancy of a short-term rental. “Enemies” are other vacation rentals that are similar to your investment property and are in the same market. It’s a colloquial term used for comparative rental analysis. 

Exit Strategy

Even before you jump into an investment, you should have an idea of how you’ll jump out. That’s your Exit Strategy. Whether it’s selling after hitting a profit target, refinancing, or something else altogether, having a game plan for the end will save a lot of headaches down the road. Remember, it’s not just about getting in; it’s about getting out gracefully and having options.

Self-Management

This is when a property owner personally handles the day-to-day management tasks of their investment property, including tenant relations, rent collection, maintenance issues, and any legal compliances. It eliminates the need for a property management company but requires time, effort, and knowledge of landlord-tenant laws.

Average Daily Rate (ADR)

This metric is used primarily in rental property investments, especially short-term rentals or hotels. It represents the average rental income earned per rented room per day. ADR is calculated by dividing the total rental income by the number of rooms rented over a given period.

1% Rule of Thumb (1% Rule)

This is a guideline used by real estate investors to evaluate rental properties. It suggests that the monthly rent of a property should be at least 1% of its total purchase price to ensure a good return on investment. This rule helps investors quickly assess a property’s income potential.

10 or 12% Rule of Thumb

This is a guideline where an investment property’s annual income should be around 10-12% of its total purchase price. 

High Season / Low Season

These terms refer to the periods of peak and low demand in rental property markets, often influenced by factors like weather, tourism trends, and local events. High Season is when demand and rental rates are typically at their highest, while Low Season sees reduced demand and lower rental rates. Understanding these cycles is crucial for pricing strategies in rental investments.

Like-Kind Exchange (1031 Exchange)

Ever wished you could swap one property for another without dealing with the taxman right away? Well, you’re in luck! The 1031 Exchange, often termed the “Like-Kind Exchange,” lets investors do just that. In essence, you’re swapping one investment property for another and deferring the capital gains tax as well as the depreciation recapture. But, and there’s always a “but”, there are specific rules to follow. Dive in deeper, and you’ll see why many real estate investors have this tool in their arsenal.

Qualified Intermediary (QI, 1031 Intermediary, or 1031 Custodian)

When you’re executing a 1031 Exchange, you can’t just swap properties willy-nilly. Enter the Qualified Intermediary! Think of the QI as the referee in this property-swapping game. They hold onto the sales proceeds when you sell your old property and then use them to buy the new one, ensuring you don’t touch the money and accidentally disqualify the exchange. These folks are crucial and often have a wealth of knowledge to share about the process.

Imputed Interest

Picture this: you lend your buddy some cash for his new venture, but you don’t charge interest. The IRS, being the ever-watchful entity, could say, “Hey, you should’ve charged interest on that!” Then, they have the ability to tax you on this ‘imaginary’ interest, even if you never saw a dime. That’s Imputed Interest for you. This is an objection that you may have to address when discussing seller financing terms.

Bonus Depreciation and Accelerated Depreciation

Imagine getting a head start in a marathon. That’s kind of what Bonus and Accelerated Depreciation offer to property owners. Instead of spreading out your property’s depreciation over decades (which can feel like watching paint dry), these tools let you claim a larger chunk of depreciation upfront. It’s a tax-saving move, especially sweet in the early years of ownership. Always check with your CPA, though, as these rules can be a moving target.

Real Estate Professional Status

Wearing the badge of “Real Estate Professional Status” is like unlocking a video game’s ultimate power-up for tax benefits. It means real estate isn’t just a side gig for you; it’s your main hustle. The IRS gives special tax advantages to folks with this status, but be warned: achieving it involves meeting specific criteria, like spending more than half of your working hours in real estate. It’s not for the casual investor but, if you qualify, the rewards can be golden! One of the best benefits is being able to offset active income with passive losses from such tools as bonus depreciation.

Material Participation

If you’re unable to attain the status of real estate professional status, you still may be able to reap the benefits of passive depreciation offsetting your active income by leveraging material participation in specific investments like short term rentals. It’s a fantastic loophole that a lot of my clients, who are high income earners, have leveraged to reduce their tax burden.

Sweat Equity

You’ve heard of earning equity by putting money into a deal, but what about equity you earn by rolling up your sleeves? That’s Sweat Equity. It’s the value you add to a property by putting in your own elbow grease, whether through renovations, management, or other hands-on work. The amount of equity earned will depend on how valuable the sweat equity is perceived by the other partners in the deal, so be prepared to negotiate your worth if this is your tactic.

Corporate Veil

Picture an invisible shield around your business, protecting your personal assets from business troubles. That’s the Corporate Veil. When you form an LLC or corporation, this veil is what keeps creditors from going after your personal goodies if things go south. But beware: sloppy business practices can poke holes in this shield. Keep business and personal matters separate, and that veil will remain strong.

Loss Runs

If you’ve ever wondered about a property’s insurance claim history, you’re thinking of Loss Runs. It’s like a report card for a property, showing all insurance claims made over a certain period. Think of it as a history lesson, giving insurers (and you) a peek into any past problems. A clean Loss Run can be a green flag, but a spotty one? That might just raise some eyebrows. You’ll ideally get the past 5 years of loss runs when purchasing a commercial property, but you’ll often be at the mercy of whatever the seller is able to offer you.