Our first post of the New Year will guide you through some of the nitty-gritty of real estate investing. For those new to the world of real estate investing or hoping to scale a successful real estate investment business, knowing the basics of the biz is imperative.
This article breaks down some key terms, tips, and strategies related to real estate and real estate investing.
A complete guide to real estate investing: at a glance
- Key terminology and fundamentals
- The three types of real estate
- What to expect from financing and taxation
- Four real estate investment strategies to consider
- Identifying your real estate investment goals
- Ensuring proper management of your investment
Terminology and fundamentals
Cash flow refers to the net capital moving in and out of an investment. In the instance of an income property, such as a rental apartment, the cash flow would be the difference between any income being produced through rent and any expenses accrued—including operating and financing costs.
Net operating income (NOI)
While cash flow is a reflection of an investment’s literal worth, net operating income is a measure of an investment’s potential worth. As such, NOI is represented by the difference between any revenue produced by the property and any operating expenses (think repairs, maintenance, property taxes, fees) excluding mortgage payments and loan costs.
Capitalization Rate (cap rate)
Capitalization rate is the measure of the annual rate of return on investment, based on the property’s NOI. As such, cap rate is represented by the difference between the NOI (over the course of one year, usually the first) and purchase price.
Capital Expenditures (CapEx)
Capital Expenditures refer to any major improvements, renovations, or retrofits made to extend the life or quality of a property. Generally, these are one-time expenses, such as installing a new furnace or replacing a roof.
Appreciation refers to how the value of an investment property increases with time. In other words, when you sell your investment property for more than you paid, that’s called appreciation.
Equity is the difference between the market value of a property and the amount, if any, still owing on a mortgage. The more you pay your mortgage, the more equity you build. Therefore, equity tends to fluctuate from day to day.
Return on investment (ROI)
Return on investment measures how much profit is made on an investment and is represented by a percentage. As such, ROI can show how effectively investment dollars are being used to generate profits. ROI is calculated by dividing net profit produced by the investment by the original cost of acquisition. Operating and financing costs also factor into ROI.
Types of real estate
- Residential real estate includes single-family homes, condos, cooperatives, duplexes, townhouses, and some multi-family residences (with fewer than five individual units).
- Commercial real estate refers to properties that generate revenue for the property owners. This category includes offices, hotels, colleges, malls, hospitals, colleges, and apartment buildings.
- Industrial real estate extends to include land and buildings that accommodate industrial activities, such as production, manufacturing, assembly, warehousing, research, storage, and distribution.
Financing and taxation
In order to receive a mortgage for your investment property, you’ll need at least 20 percent of the purchase price for a down payment. That percentage increases to 50 percent for commercial property investments. That said, if you’re investing in an income property (in particular, something in the multi-family asset class), your chances at getting approved for a loan are bolstered by the fact that the property will render consistent cashflow via rent collection.
Different property types are subject to various types of tax. In general, the amount of tax that a property is subjected to is derived from a percentage of the assessed value of the property. Additionally, any money collected from rent is considered income. As such, that revenue is subject to income tax. Finally, any appreciation in the value of your investment property is subject to capital gains taxes.
Income properties refer to anything that generates income, usually through rent collection. The most lucrative form of income properties in today’s market are multi-family apartment buildings, which are high in demand and allow for consistent and long-term cash flow. For that reason, property owners can pay off the mortgage of the property faster, building equity.
Mixed-use properties have both a residential and a commercial component. This means that they offer an income-producing component, which bodes well in terms of financing options, as well as the ability to build equity through a mortgage pay-down. As well, mixed-used properties offer diversification of income streams, which can help the property to sustain performance during times of economic uncertainty.
Flipping involves purchasing a property, improving it, and reselling it for a profit. This strategy requires upfront capital, but without a guaranteed timeframe of return. Flipping is ideal if you have significant experience in real estate valuation, marketing, and renovation—in addition to the time and patience to see the project through.
This strategy involves purchasing properties during the pre-construction phase and reselling them post-construction. On the bright side, opting for new construction means you won’t have to perform any capital upgrades. That said, the downfall is that you’re at the mercy of builders, who have the latitude to cancel or post-phone a project.
Generally speaking, some sort of return is expected from a given investment. That said, the success of an investment can be measured in a few different ways: (a) a cash return (usually through rent collection) that exceeds the expenses you pay out, (b) appreciation in the asset’s value, or (c) a mortgage pay-down, leading to increased equity.
If you want to get into real estate investing but are unsure of your strategy, a good place to start is by identifying your preferred investment goal. For instance, income properties are favourable investments of your investment goal is to generate steady cash flow or even build equity. Alternatively, if your goal is appreciation, then you might consider a flipping strategy, which is geared at selling a property for more than you paid for it.
The bottom line
As anyone with experience in real estate investing will tell you, the key to a successful investment is oftentimes in the management. You can secure a promising investment, but without proper management of that investment, you may never see its full potential. Real estate investment groups (REIGs), such as privately-run funds and partnerships, are ideal for people who want to own rental real estate, but lack the time or experience-base necessary to seek out and manage such opportunities. In other words, REIGs offer a hands-off way to have a stake in today’s flourishing real estate market.