Investing in Commercial Property
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Investing in Commercial Property
Every industry has their own jargon that’s used. If you’re involved with stock trading, you may hear words like bear market or blue chip, while in the tech industry, phrases like content curation and website optimization are common. Real estate investing has its own lingo too, and if you’re just getting started with it, it’s important that you familiarize yourself with these words, so you can hold intelligent conversations with others in the biz, and actually know what you’re talking about!
Here are some of the words and phrases to add to your growing real estate investing vocabulary:
Appreciation - This refers to how much a property increases in value over time. Many factors can affect appreciation including inflation, changes in supply and demand for real estate, desirability of a neighbourhood / area, and forced value due to things like property improvements or upgrades.
Cap rate - Capitalization rate, or cap rate, is the value or return on the investment. Cap rate is shown as a percentage and is derived by taking the net operating income (see below) and dividing it by the current value of the property. Most investors want to see a cap rate of between 7 and 11% on an investment property.
Cash flow - This is all the money that is flowing in and out of the investment. Cash flow can be positive or negative, as both income and expenses (including mortgage payments) are factored into it. With a real estate investment, you want positive cash flow each month - that is, money left over after you subtracted all monthly expenses from the monthly income.
Equity - Equity refers to how much ownership an investor or homeowner has in a property based on its market value. For instance, if you buy a property outright with cash, you have 100% equity because you own the property entirely. However, if you used a mortgage to purchase the property, you only own a certain percentage of the property, and the bank or lender owns the remainder. As you pay down the loan, your equity increases.
Leverage - Leverage is the use of a mortgage or other borrowed capital to maximize returns for your own benefit. In other words, if you buy an investment property using a mortgage, even though you don’t own the property free and clear, you are still able to use the whole value of the house (which will hopefully be increasing due to appreciation) to secure other investments. Basically, you’re making other people’s money work for you.
LTV - Loan to Value, or LTV, is the amount of a loan compared to a property’s value. This is one of the factors that banks and other lenders use to determine how much risk they’re taking on and ultimately how much they’ll let you borrow. For instance, if a property’s appraised value is R10 000 000.00, and you’re asking to borrow R6 000 000.00 to buy the property, the LTV would be 60%. From the lender’s perspective, the higher the LTV, the more risk.
NOI - Net operating income is the amount left over after all operating expenses have been deducted from all income the property is generating. Income is mostly made up of rent but could also include other forms of revenue. Operating expenses include assessment rates, insurance, repairs/maintenance, vacancy provision, and other miscellaneous expenses. This does NOT include mortgage payments as NOI reflects only what you would make if you owned the property free and clear.
Vacancy provision - The vacancy provision is a percentage of the monthly or annual rent that is factored into the overall expenses associated with a property to cover the time the property may be vacant during a given year.
These are just a few of the terms you’ll want to know as you become more involved with investing. If you are looking to acquire or dispose of Investment Property contact Graham Marder on 011 453 1220.
Author: Graham Marder
