Amortization – a gradual paying off of a debt by periodic installments.
Annual Debt Service – required annual principal and interest payments for a loan.
Appraisal – an opinion or estimate of the value of a property.
Appreciation – an increase in the value of a property.
CAP Rate – A capitalization rate (or “cap rate) is a measure of the ratio between the cash flow produced by an asset (usually real estate) and its capital cost (the original price paid to own it). The rate is calculated as follows:
- Annual cash flow/Capital Cost = Capitalization Rate
For example, if a building is purchased for $1,000,000 and it produces $100,000 in positive net cash flow (the amount left over after fixes and variable costs are subtracted from the gross lease income) during one year, then:
- $100,000/$1,000,000 = .10 = 10 percent
The asset’s cap rate is ten percent.
Cash Flow – periodic amounts left over for an investor after deducting all expenses and payments from rental income. Sometimes also called “cash throw-off”.
Closing Costs – Various fees and expenses payable by the seller and buyer at the time of a real estate closing. Some of the closing costs are:
- brokerage commissions (paid by the seller)
- lender discount points/other fees
- title insurance premium
- deed recording fees
- inspection and appraisal fees
A good rule of thumb is to estimate your closings costs to be about three percent (3%) above the purchase price of the property.
Depreciation – is an accounting term used to spread the cost of an asset over a span of years. In layman’s terms, it’s how quickly something gets used up or worn out. Different assets have different rates of depreciation, and are allocated according to these depreciation schedules.
Building Value – Depreciation on residential income property is typically 27.5 years.
Land Value – The worth of the land the asset is on. As land never gets used up, it doesn’t depreciate.
Land Improvement Value – Land improvements include things like landscaping, driveways, the garage, the water line from the
street to the property, etc. These items are typically depreciated over a span of 15 years.
Personal Property Value – Items like carpeting, appliances, lawn mowers and rakes are considered personal property. They are typically
depreciated over five years.
If you owner occupy a multi-family property, you can depreciate the portion that is not for personal use. The portion you live in would not qualify as a deductible tax expense.
Earnest Money – A deposit made by a Buyer when submitting a purchase agreement as evidence of good faith. In other words, the Buyer is putting up money to put legitimacy to her offer. This amount is held in a Broker’s account, then applied toward the Buyer’s down payment at closing.
FHA Mortgage Loan – A mortgage loan insured by the FHA or Federal Housing Administration. A buyer with insufficient funds to make a large down payment may finance more than the conventional 80 percent of value, with the FHA insuring the amount of the loan.
Gross Rent Multiplier – The sales price divided by the total amount of annual rent.
Hazard Insurance – A form of insurance that protects against certain risks, such as from fire or storms.
Lease – A contract renting land, buildings, etc., to another; a contract or instrument conveying property to another for a specified period or for a period in consideration of rent or other compensation.
Market Value – The theoretical highest price a willing buyer would pay, and the lowest price a seller would accept.
Net Operating Income or NOI – Income from property or business after operating expenses have been deducted, but before deducting income taxes and financing expenses.
Operating Expenses – Amounts paid to maintain property, such as property taxes, utilities and hazard insurance. Does not include financing expenses and depreciation.
Vacancy Rate – The percentage of all units not occupied or rented. To estimate annual Twin Cities metro vacancy rates, consult the Minneapolis Star & Tribune Homes section in the Saturday edition.