Welcome to Physicians and Properties
As a physician, you’re no stranger to complex medical terminology. But, when it comes to real estate investing, there’s a whole new vocabulary to learn. From cap rates to cash-on-cash returns, the world of real estate investing can seem like a foreign language. But fear not! We’ve put together a beginner’s guide to help you navigate some of the most important real estate investing terms.
The first real estate investing term we are going to discuss is appreciation. Simply, this is the increase in the value of a property over time. Fortunately, appreciation can be caused by a variety of factors, including market trends, renovations, and improvements to the property.
The use of borrowed money to finance an investment. In real estate, leverage can increase returns, but it also increases risk. An example of leverage is a mortgage. Amazingly, you can buy an asset for 0-20% down or more allowing you to leverage the banks’ money to buy a more valuable asset.
The value of a property minus any outstanding mortgage balance. Equity represents the portion of the property that the owner actually owns. This can be recaptured when the property is sold or with a cash-out refinance or home equity line of credit.
The decrease in the value of a property over time. Depreciation can be used to reduce taxable income and improve cash flow for real estate investors. Also, stand by for a blog post on the power of using accelerated depreciation from a cost segregation study to maximize tax benefits, it is awesome!
Of all these real estate investing terms, this one is my favorite. Personally, I think this is the most important. As you have learned, I am trying to generate $10,000 in semi-passive real estate income by June 2025. Cash flow is simply, the net income generated by a property after all expenses are paid. This is the cash that goes into your pocket/bank.
Net Operating Income
Net Operating Income (NOI) is a critical financial metric in real estate investing that measures the profitability of a property. It’s the income generated by a property after all operating expenses have been deducted but before mortgage payments, taxes, and other non-operational expenses are taken into account. NOI is used to calculate other financial metrics like the capitalization rate (cap rate) and cash flow, making it a key indicator of a property’s profitability. It reflects the income generated by the property on an ongoing basis, independent of the owner’s financing and tax situation, and is calculated by subtracting operating expenses from the gross income of the property.
The capitalization rate, also known as the cap rate, is a ratio used to evaluate the profitability of a commercial property. It’s calculated by dividing the property’s net operating income (NOI) by its current market value. The resulting percentage represents the rate of return an investor can expect to earn on their investment in the property.
The cap rate is commonly used to compare different investment opportunities and to assess the relative value of different commercial properties. Generally speaking, a higher cap rate indicates a more profitable investment, while a lower cap rate suggests a lower return on investment. However, it’s important to note that the cap rate should be used in conjunction with other metrics, such as cash-on-cash return, to evaluate the overall performance of a commercial property.
The cap rate can also be used to estimate the potential resale value of a commercial property. By projecting future NOI and applying the current cap rate, an investor can estimate the potential market value of the property at a future point in time.
Cash-on-cash return is a ratio used to measure the cash income earned on the cash invested in a property. It is calculated by dividing the property’s net operating income (NOI) by the total cash invested. Typically, a higher cash-on-cash return indicates a higher return on investment.
Internal Rate of Return (IRR)
The internal rate of return (IRR) is a metric used to calculate the potential profitability of an investment. It takes into account the time value of money and the cash flows generated by the investment over time. A higher IRR indicates a higher return on investment.
Debt Service Coverage Ratio (DSCR)
The debt service coverage ratio (DSCR) is a ratio used to determine a property’s ability to generate enough income to cover its debt payments. It is calculated by dividing the property’s net operating income (NOI) by its debt service. A higher DSCR indicates a lower risk of default.
The percentage of time a property is vacant. A high vacancy rate can lead to a decrease in rental income and profitability. Of course, if no one is paying rent you are not making any money.
Capital expenditures (capex) are expenses incurred by real estate investors to improve or maintain a property’s value over time. These expenses are typically for major renovations or upgrades, such as replacing a roof, upgrading a heating system, or renovating a kitchen. However, unlike operating expenses, which are regular expenses required for day-to-day operations, capital expenditures are one-time or infrequent expenses that can have a significant impact on the value of a property. As a new physician real estate investor, it’s important to budget for capital expenditures as part of your overall investment strategy, as they can impact cash flow and future profitability.
PITI is short for Principal, Interest, (Real Estate) Taxes, and Insurance. This abbreviation refers to the various components that make up a mortgage payment. Most residential mortgages have a monthly payment that includes PITI.
By understanding these real estate investing terms, you’ll be better equipped to evaluate potential investments and make informed decisions about your portfolio. Of course, this is just the tip of the iceberg when it comes to real estate investing terminology, but it’s a great place to start building a foundation of knowledge. Do you want to know why you should invest in real estate, click here! If you learned something, please share this with a friend!