Working in the real estate investment industry for more than 20 years, the language that surprises or distracts some, just became a part of my everyday vernacular. That being said, it can also be the very language that limits a new investor early on or scares them off altogether. As a result, I wanted to follow up my previous post with a few more definitions of key terms to know when you just start out.
Net Operating Income is the formula for calculating the profit you bring in after all of your monthly expenses. “The NOI is calculated on an annual basis and equals the Net Rental Income (total rent for the year minus vacancy), minus the Operating Expenses (this is all costs for maintaining the property, including real estate tax, insurance, maintenance, management, utilities, landscaping, legal, leasing commissions, etc.—everything EXCEPT the mortgage payment.) Sometimes people include “Capital Expenses” as an expense also.” Many investors start informally calculating this number before they even consider purchasing a property. This requires rough estimates for expenses and an understanding of the estimated rental value of the property.
As explained here, “The cap rate percentage is found by dividing the net operating income of a real estate asset (expenses minus income) by the current value of the asset.” It’s also important to remember that the equation is based on the value at the time, not at the purchased value.
Many investors require a loan from the bank, at least when first starting out. A lot of factors go into securing a loan for a property investment because the bank has to ensure that it’s also a sound investment for them as an institution.This formula, debt service coverage ratio (DSCR), helps banks to evaluate the amount of risk. As Than Merrill explains, it “measures NOI in comparison to annual debt payments.”
The paperwork that comes along with any real estate purchase seems pretty inevitable. What people don’t always consider is that it continues through the leasing process, various tenants and more. This is why CCR or Conditions, Covenants and Restrictions becomes especially important. CCR acts as an opportunity for you to safeguard yourself and your customers. As Ken Horst says, it’s really a case by case situation. “There can be CCRs written into a deed when you purchase a property. Also, your tenants could sign a rental agreement in which they agree to certain conditions (such as “no pets allowed” and “you can live here as long as you pay rent, otherwise we can evict you”).” The important thing is knowing that all your bases are covered.