20 Terms you need to know

1. Net Operating Income (NOI)

  • Definition: The income generated from a property after subtracting all operating expenses, excluding mortgage payments and taxes.

  • Importance: NOI is used to determine the profitability of a property and is essential for calculating other metrics like Cap Rate and Debt Service Coverage Ratio (DSCR).

  • Formula: NOI=Gross Rental Income−Operating Expenses\text{NOI} = \text{Gross Rental Income} - \text{Operating Expenses}NOI=Gross Rental Income−Operating Expenses

2. Cap Rate (Capitalization Rate)

  • Definition: A measure of a property's rate of return based on its NOI and purchase price or current market value.

  • Importance: Used to compare the profitability of different investments and assess the potential return on investment (ROI).

  • Formula: Cap Rate=NOIPurchase Price or Market Value\text{Cap Rate} = \frac{\text{NOI}}{\text{Purchase Price or Market Value}}Cap Rate=Purchase Price or Market ValueNOI​

3. Cash-on-Cash Return

  • Definition: A metric that shows the return on the actual cash invested in a property, not taking into account the total property value or appreciation.

  • Importance: Helps investors evaluate their return on the cash they put into a deal, often used in syndications.

  • Formula: Cash-on-Cash Return=Annual Cash FlowTotal Cash Invested\text{Cash-on-Cash Return} = \frac{\text{Annual Cash Flow}}{\text{Total Cash Invested}}Cash-on-Cash Return=Total Cash InvestedAnnual Cash Flow​

4. Debt Service Coverage Ratio (DSCR)

  • Definition: A ratio that measures a property’s ability to cover its debt payments from its NOI.

  • Importance: Lenders often use DSCR to assess the risk of lending on a property; a higher DSCR indicates a safer investment.

  • Formula: DSCR=NOIDebt Service (Principal + Interest Payments)\text{DSCR} = \frac{\text{NOI}}{\text{Debt Service (Principal + Interest Payments)}}DSCR=Debt Service (Principal + Interest Payments)NOI​

5. Gross Rent Multiplier (GRM)

  • Definition: A simple measure of a property's value relative to its rental income.

  • Importance: GRM is used to compare properties, but it doesn't take into account operating expenses or financing.

  • Formula: GRM=Property PriceAnnual Gross Rental Income\text{GRM} = \frac{\text{Property Price}}{\text{Annual Gross Rental Income}}GRM=Annual Gross Rental IncomeProperty Price​

6. Capital Expenditures (CapEx)

  • Definition: The funds used to improve, repair, or maintain the property’s physical assets (e.g., roof replacements, HVAC systems, structural repairs).

  • Importance: CapEx is essential for maintaining the value of a property and increasing rents or property value. Investors should budget for CapEx to avoid deferred maintenance.

7. Operating Expenses

  • Definition: The ongoing costs required to run and maintain a property, such as property management fees, repairs, insurance, utilities, and property taxes.

  • Importance: Operating expenses directly affect NOI and cash flow. High expenses can erode profitability.

8. Vacancy Rate

  • Definition: The percentage of all available units in a rental property that are vacant at a given time.

  • Importance: A higher vacancy rate can negatively impact cash flow and NOI. Investors aim to keep vacancy rates low through effective management and tenant retention.

9. Loan-to-Value Ratio (LTV)

  • Definition: A ratio used by lenders to assess the risk of lending, calculated as the loan amount divided by the property’s appraised value.

  • Importance: A lower LTV means less risk for the lender and often leads to better financing terms for the borrower.

  • Formula: LTV=Loan AmountProperty Value\text{LTV} = \frac{\text{Loan Amount}}{\text{Property Value}}LTV=Property ValueLoan Amount​

10. Syndication

  • Definition: A structure where multiple investors pool their capital to collectively purchase a property, often with one or more sponsors who manage the investment.

  • Importance: Syndication allows smaller investors to participate in larger multifamily deals by investing passively.

11. Value-Add Property

  • Definition: A property that requires improvements or renovations to increase its value and cash flow potential.

  • Importance: Value-add properties are often targeted by investors looking to enhance returns through property improvements and rent increases.

12. Capital Stack

  • Definition: The hierarchy of capital used to finance a property, typically made up of debt (loans) and equity (investor contributions).

  • Importance: Understanding the capital stack helps investors assess the risk and potential return of a deal. Equity investors typically bear more risk but also have higher upside.

13. Preferred Return (Pref)

  • Definition: A predetermined return given to investors in a syndication before the sponsor takes any share of the profits.

  • Importance: Preferred returns protect investors by ensuring they receive a minimum return before profits are split between the sponsors and investors.

14. Internal Rate of Return (IRR)

  • Definition: A metric used to estimate the profitability of an investment over time, taking into account the time value of money.

  • Importance: IRR gives investors a better understanding of the long-term profitability of a multifamily investment and helps compare multiple investment opportunities.

15. Equity Multiple

  • Definition: A measure of an investor’s total return on their equity investment, including cash flow and profits from the sale of the property.

  • Importance: It shows how much money an investor can expect to make on their initial investment.

  • Formula: Equity Multiple=Total Cash DistributionsTotal Equity Invested\text{Equity Multiple} = \frac{\text{Total Cash Distributions}}{\text{Total Equity Invested}}Equity Multiple=Total Equity InvestedTotal Cash Distributions​

16. Pro Forma

  • Definition: A projection of a property’s financial performance, often used in the underwriting process to estimate future income, expenses, and cash flow.

  • Importance: The pro forma helps investors evaluate the potential of a deal by forecasting cash flow, NOI, and returns based on assumptions about rent growth, expenses, and vacancy rates.

17. 1031 Exchange

  • Definition: A tax-deferred exchange that allows investors to sell one investment property and reinvest the proceeds into another similar property without paying capital gains taxes immediately.

  • Importance: A key tool for multifamily investors to grow their portfolio and defer taxes while reinvesting in larger or more profitable properties.

18. Escrow

  • Definition: A third-party account where funds are held until certain conditions (e.g., inspection, financing) are met during the property purchase process.

  • Importance: Escrow protects both the buyer and seller in a transaction by ensuring that funds are only released when the terms of the contract are fulfilled.

19. Turnover

  • Definition: The process of preparing a vacated unit for a new tenant, which may include cleaning, repairs, and renovations.

  • Importance: High turnover rates can increase vacancy and operating expenses, negatively impacting cash flow.

20. Rent Roll

  • Definition: A report that details the current leases of a property, including tenant names, unit numbers, rental rates, and lease expiration dates.

  • Importance: A rent roll helps investors assess the current income of a property and potential future rent increases or vacancy risks.