Like every industry, real estate investing has its own vocabulary—terms that are pertinent to conducting business. Yet, unlike in some industries, where the lingo is developed around cute buzzwords, in real estate investing there are crucial concepts that you need to know.
Developing an understanding of real estate investing terms is key when starting out; trust me, I know. There are complicated financial, legal, and practical terms and ideas that define the business which can help you understand how to make the right moves.
If you are starting out as a real estate investor, knowing the basic vocabulary can give you a great headstart. I wish I’d had a handy guide like this when I first began.
The Ultimate Guide to Real Estate Investing Terms
What do you need to know? Here’s a start.
The 70% rule refers to a formula that many real estate investors use to determine the price they should pay when they find a home for sale that they intend to fix and flip. This formula for wholesaling is supposed to provide guidance on how much you should pay for a house but it isn’t always accurate.
You’re going to come across a lot of “rules” for real estate investing but be careful because they don’t always work. Remember that real estate investing changes in every individual situation.
After Repair Value (ARV)
ARV is both a financial concept and the heart of real estate investing. It stands for after repair value—how much can you sell a house for after investing in its rehabilitation. This is what you want to be able to calculate when making a decision to buy a house. When determining the ARV, you must take into account the neighborhood and the market, among other factors. Having valuation tools can help you determine an approximate ARV.
When you are buying homes quickly for cash, you buy them as-is. That means the seller doesn’t have to do any repairs. You make your offer taking into account the work you have to do, so the seller doesn’t hold any of that responsibility. Obviously, this usually results in a lower price than if the seller made the repairs, but their need (to sell fast) and your need (to put money into the house) sync up.
This isn’t about being cold; this is a formula touted by some as an easy way to make money. BRRRR stands for “Buy, Rehab, Rent, Refinance, Repeat.” The idea is that you buy a property, fix it up, rent it to start getting passive income, refinance that property in order to get money to buy another, and start the cycle again. BRRRR is supposed to be easy, but it can be very risky if you aren’t able to rent it out or don’t have a great house to buy quickly.
A “buy-and-hold” is a real estate investing strategy where you purchase a property and hold onto it with the intent of selling it later at a higher price than what the current market might offer. This can be a good strategy when the market is trending toward rentals instead of homeownership. It could be a great way to have a source of passive income, though it doesn’t provide the immediate liquidity of a sale.
Capitalization (Cap) Rate
The capitalization rate is a key concept for investors buying properties to rent out. It is a formula for the return of investment on a rental property. You calculate the cap rate by taking the annual income and subtracting the operating expenses (to get the net income), and dividing that by how much you paid. Basically, you are figuring how much of your initial investment you can make back every year.
It’s important to know there is no “ideal” cap rate since it depends on your needs and the market you are in. The area cap rate refers to the standard cap rate in your region. What might be a great cap rate in one market could put you in the red in another. The cap rate for a single-family house can range between 4% and 10%
Cash flow is how much money is coming in from your property. This usually relates to rental properties, as they’re oftentimes a steady source of passive income. If you are selling houses, though, you also maintain a cash flow. Having steady cash is very helpful in a business that is based around liquidity.
In most areas, “depreciation” is a negative thing. But when it comes to taxes related to rental property, depreciation may be your best friend. It can allow you to deduct the costs of buying and improving a property from your taxable income. This can help lower what you’re paying every year. Of course, talk to tax professionals about how to take advantage of depreciation before assuming you can benefit.
A distressed homeowner is someone who may be facing foreclosure, taxes that they can’t pay, or any number of difficult circumstances that make them want to sell quickly. Marketing to distressed homeowners is about building trust and treating them fairly. These are the homeowners from whom you’ll be buying most of your property, so understanding who they are and what they are going through is key to your business.
These are the houses owned by distressed homeowners. They may or may not need a lot of repair, and may or may not be swarming with liens and debts. Sometimes, these properties can be bought as-is, quickly, without a lot of red tape. The key is being able to present the right solution for the distress. Knowing how to find and buy distressed properties is crucial to your real estate investing business.
What are you going to do with a property once you buy it? That is your Exit Strategy. When are you going to sell? How long are you going to rent out a place? How much work are you going to put in a house before you put it on the market? Do you have a network of buyers to which you plan to wholesale? Never buy a property without a plan. Don’t think of an exit strategy as a last step; you should have a plan in place before you buy that house.
This is what most people think of when they think of real estate investing. It is also the most popular of the top three real estate investment strategies. This is when you buy a house, put some work into it, and sell it. It’s simple, but not easy. You need to know how much work to put into it and what the market will bear. This isn’t about turning a run-down shanty into a mansion. It’s about getting a house to a point where you can see reasonable returns from a sale. A fix and flip mentorship is a great way to learn how to do this.
Sometimes you buy a house that needs no work. A lot of times it needs a little work. And then there are houses that need a lot of work to get up to market standards. Finding these fixer-uppers is how you make your bones in this business. Remember that you don’t want to spend time and money to fix something when the ARV won’t play out well. Maybe you can get a buyer to spend a million dollars in a neighborhood that usually sells for a quarter of that, but not likely.
A foreclosed house is where the bank (or another financial entity) has taken control of the house from an owner who couldn’t pay the mortgage or taxes on a property. Buying foreclosures from an auction is a very common way of obtaining properties, but there are a lot of downsides to searching for foreclosures—higher costs, less visibility into the condition of the house, and a ton of competition. It is better to buy directly from distressed homeowners if possible.
Gap funding is when you take out a loan and then, you suddenly find yourself out of liquid money—for example, if rehab costs were higher than expected. Obviously, this isn’t an ideal situation. Gap funding can help you finish a project or buy another property, but it also adds to your expenses.
Hard money is the financial backbone of this business, the cash flow that supports nearly all your work. Hard money lenders understand the real estate investing business and know that you need money quickly. They are more expensive than banks, but for an investment property, they are generally more preferable to banks, who move slowly and often don’t offer suitable financial products. Different hard money lenders have different rates and terms, and in general, you’ll get better rates the more experience and success you have. This is a liquid business, and knowing how hard money works can keep your business growing.
To say you need leads in real estate is akin to saying you need water to swim. A lead generation strategy is critical to your success. Otherwise, you will just be popping up at auctions and hoping for the best. There are a lot of different ways to generate leads. Marketing, hiring a realtor, door-to-door, searching online, and being part of a network of investors are all ways that real estate investors find leads. But bear in mind that not every lead is a quality lead. You have to garner a positive ratio of quality leads to time and money spent.
Passive income is the income you get from rental properties. Many real estate investors have multiple rental properties as sources of passive income. It’s a great way to have some money coming in regularly. Of course, you will also be spending time and money on upkeep but that’s why it’s important to understand the cap rates in your market.
Sometimes sellers are just testing the market or beginning to look around. Wooing them is a waste of time. As a real estate investor, you want to find people who are ready and eager to sell. A motivated seller might have acquired a home from an inheritance that they can’t maintain or they need to sell because of a divorce. Whatever the unfortunate circumstance, they are looking to sell it fairly quickly.
The LTV is a ratio that lenders use to determine whether or not to loan, or at which rates to loan. To get a hard money loan, for instance, you need to be able to show that the costs of buying and rehabbing the house make sense in terms of what you can actually sell the house for. Hard money lenders will often base their LTV calculation on the after repair value of the house, unlike traditional banks, and base their funding decision on the cost of the rehab.
Proof of Funds
This is what you will need to show the homeowner to prove that you actually have the financial ability to buy their house. You can get a proof of funds letter from your hard money lender—they are used to acting fast when you have a good deal on your hands. Ideally, you have already built a relationship with a lender before you approach a distressed homeowner. Time is money, and if you are not prepared, you just might lose credibility with the home seller—and the deal.
Return on Investment (ROI)
The return on investment (ROI) on a property involves how much pocket change you will earn after accounting for buying, rehabbing, and selling it. But there are other types of ROIs to consider as well. What is the ROI on your marketing strategy, for example? Are you getting quality leads from marketing efforts, or just throwing away money? Anything you do should offer a positive return on investment, if not immediately then at least as part of your overall plan.
Real Estate Investing Guru
There are a lot of people who consider themselves real estate investing gurus and oftentimes they’re eager to share what they’ve learned. They’re willing to tell you how to get rich quick, if you just follow their “Five Simple Rules for Investing,” or whatever. They have a system and they are happy to let you pay them to learn it. Some of them may have good advice to offer but they’re usually no longer actual working real estate investors. A real estate guru isn’t your role model. It’s generally preferable to get mentorship from someone who knows the business than someone whose business is telling you what they know.
There are many benefits to real estate investing after retirement, or as you are preparing to do so. It can provide a source of income, whether active or passive, to grow your financial security later in life. But even when you have years of career experience behind you, it’s good to make sure you have the best information, training, and resources you need to get started.
A sheriff’s sale is a public auction of houses that have been foreclosed on for any number of reasons, including unpaid tax debt, liens, or abandonment. It’s a very popular way for real estate investors to find houses to buy but there are also drawbacks. It’s often hard to learn much about the houses for sale in advance, which means you could be on the hook for a lot of repair work and other legal expenses. There is also a lot of competition at most sheriff sales, which drives the prices up.
A short sale is when a lender agrees to let you buy a house for less than what is owed by the homeowner. The homeowner may be underwater on their mortgage, owing more than the house is currently worth, or even facing the potential of foreclosure. This is in theory a good practice, but short sale listings aren’t always your best bet. There is a lot of competition for them, and banks don’t even have to approve a short sale. Sometimes they won’t. And sometimes houses are placed on short sale lists prior to lender approval, which means you may be inquiring in the wrong place.
Wholesaling is a rapid-fire form of real estate investing where you buy a distressed property and then quickly sell it to another investor who will fix and flip or hold onto it. Your margins are smaller than if you did the rehab yourself, but the smart wholesaler works in volume. You have to have a network of buyers ready, since any time spent holding onto the house costs money.
The Best Way to Turn Real Estate Knowledge into Action
All of these real estate investing terms are helpful to know. This is a very complicated business, where you are navigating between sellers, lending institutions, contractors, and buyers or renters. That is why no one should start out alone. Everyone needs support.
For many, including myself, that support comes in the form of being an independently owned and operated HomeVestors® franchisee. I have a nationwide lead generation machine behind me, which gets me quality leads. I have tools and technology to help me make smart moves and get hard money loans.
Being a franchisee also connects me to a network of other professionals, including people ready to buy from wholesalers. For the less experienced investor, it comes with training and mentorship that turns these vocabulary lessons into reality.
If you feel ready to start your real estate investment business, request information about becoming a franchisee today.
Each franchise office is independently owned and operated.