Real Estate Investment Terminology
If you’ve just decided to begin investing in San Diego residential real estate investment properties, you may not yet be familiar with all of the terms you’ll hear. This short list should bring you up to speed:
LOAN TO VALUE (LTV): The loan amount divided by the price, expressed as a percentage. For instance, if you’re purchasing a $200,000 property and your loan will be $150,000 your LTV will be:
150,000 divided by 200,000 = 0.75 or 75%
The lower the LTV, the better rate you’ll get on a purchase loan. It’s the loan amount as it bears to the whole value. $80,000 loan on a $100,000 would be an 80 LTV.
NET OPERATING INCOME: This is the income received from rents after all operating expenses have been deducted. Operating expenses include repairs and maintenance, insurance, management fees, utilities, supplies, and property taxes. Operating expenses do not include principal and interest, capital expenditures, depreciation, income taxes, and amortization of loan points.
The net operating income is used in determining the cap rate and the debt coverage ratio.
CAP RATE, also called RATE OF RETURN: This is the ratio of net operating income divided by the purchase price, expressed as a percentage. The higher the cap rate, the better, because it indicates a larger rental income. A cap rate of 6% is a good starting point for an investor.
For example, a property purchased for $200,000 yields $18,200 net income per year.
$18,200 divided by $200,000 = 0.09. Thus the cap rate is 9%. You want higher cap rates as an investor.
DEBT SERVICE: The yearly sum of your monthly principal and interest payments, and any fees associated therewith.
DEBT COVERAGE RATIO: If you’re financing your San Diego residential income property, the bank will want to see that your incoming rents will cover your outgoing debt service. To arrive at this figure, divide the annual net operating income by the debt service.
For instance, if your net operating income is $50,000 and your annual debt service is $40,000, you’d divide $50,000 by $40,000. The resulting 1.25 is your debt coverage ratio.
GROSS SCHEDULED INCOME (GSI): The maximum rents that will be received if your San Diego rental income property is fully rented for the entire year. Since vacancies do occur, and you may be able to increase rents, actual income may be different.
GROSS RENT MULTIPLIER (GRM): This is the price divided by the income. This is typically determined by examining comparable properties in the marketplace.
PASSIVE (OR ACTIVE) INVESTOR: A passive investor is a non-real estate professional or a real estate investment portfolio investor. An active investor has a “hands on,” decision-making position in his or her investments.
DEPRECIATION – ALSO CALLED COST RECOVERY: Residential improvements (buildings) can be depreciated over 27.5 years. Provide your tax adviser with all financial documents related to the purchase of your residential income property, including a break-out of the values of the land and the improvements.
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P.S. If you’re thinking of a property and want to see how the numbers play out, use our San Diego residential real estate investment calculator.