Accessory Dwelling Unit (ADU)
An ADU is a smaller home built on the same lot of land as the primary dwelling. It could be a free-standing structure, such as a guest house, or an apartment built on top of a garage. ADU’s have their own entrance but typically share the same address as the primary home.
An accredited investor is someone who qualifies as a financially sophisticated investor, based on income, assets, or experience, according to SEC guidelines. This status allows investors to hold investments that fall outside the direct oversight of the SEC. The SEC regulates traditional investments like stocks and bonds, but private investments (like real estate syndication) fall outside the SEC’s oversight and require accredited investor status.
Annualized returns are investment yields, adjusted to reflect the return based on a 12-month period. The annual return is useful when comparing investments because it allows investors to see how each investment performs over a standard one-year period.
Appreciation is an increase in the value of an asset. When you invest in real estate, the goal is for the property to appreciate in value over time, so you get a healthy return on the investment when you sell it. Appreciation depends on a number of factors, including demand, supply, improvements made to the property, interest rates, inflation, and thelocal real estate market.
Cap rate (also called capitalization rate) is the ratio between the net operating income (NOI) and the purchase price of a property, expressed as a percentage. To calculate the cap rate, divide the NOI by the property purchase price. Example: If you purchase a property for $150,000 with an estimated NOI of $12,000 in the first year, you get a cap rate of 8% ($12,000/$150,000=0.08).
Capital gains are the profits earned on the sale of assets (profits being the money earned from the sale minus the expenses incurred).
Cash flow is the way money moves in and out of a company, investment, or account. In real estate investing, cash flow generally refers to recurring net income from property rentals.
The cash-on-cash return is the cash income made on the cash invested in a property, expressed as a percentage. It measures the annual return the investor made in relation to the amount of mortgage paid during the same year. To calculate the cash-on-cash return, divide the annual pre-tax cash flow from the total cash invested.
Cash reserves are money that must be kept available to meet any unexpected or emergency funding needs.
Class A Property
Class A properties are the highest-quality class of property. Class A properties are under 15 years old, built in prime locations, demand high rents, and have little or no deferred maintenance issues.
Class B Property
Class B properties are typically older than class A properties. They are generally well maintained but may have some deferred maintenance issues and value-add opportunities.
Class C Property
Class C properties are over 20 years old with substantial deferred maintenance issues and are likely to be in less desirable locations.
Class D Property
Class D properties are old, in poor shape, and require substantial renovation or even a tear-down and rebuild to be worth investing in.
Closing costs are the expenses required to close escrow on a property. When buying property, closing costs include items like inspections, appraisals, loan fees, title search fees, document filing fees, and prorated property taxes and insurance. When selling a property, closing costs include items like real estate agent fees and any unpaid property taxes or utilities.
Commercial Real Estate
Commercial real estate typically refers to business-related workspaces, such as an office building, shopping center, restaurant, or hotel. However, a residential property consisting of five or more units is also considered a commercial property.
Compounded interest is when you earn interest on the interest you have already earned.
Real estate crowdfunding is when several people invest in a particular property together, allowing each investor to have a share percentage in the property. Investors are usually connected through online sites. The crowdfunding platform manages the project until completed and distributes profits from the property to investors.
Depreciation is a tax deduction for owners of income property based on the declining value of the structure over its useful life.
A development is a completed real estate structure. This term is most often used to reference a commercial property or multi-family residential property, but it can also be used to reference single-family homes, particularly when they are of high value.
A down payment is the amount of the purchase price that must be paid upfront to buy a piece of real estate.
Due diligence is the research that a reasonable person is expected to complete before making a big decision like purchasing a property or entering into a contract.
Entitlements are the governmental approvals needed in order to build commercial real estate.
Equity is the value of an asset (like a real estate investment), minus the amount still owed in the financing of that asset (like a mortgage).
An equity multiple measures the rate of return on an investment based on distributions received. To calculate the equity multiple, divide the total amount distributions received by the total capital invested.
Escrow is when a third party holds money on behalf of two parties engaged in a deal. In real estate, escrow is opened with an escrow company as soon as a property is under contract. The escrow company will hold the money on behalf of the buyer and seller until the transaction is completed, at which point the escrow company distributes the cash to the appropriate parties and escrow is closed.
Flipping is a real estate investment strategy of purchasing a property, renovating it quickly, and reselling it immediately.
Gross profit is the total money made on the sale of an asset minus the cost of purchasing the asset.
The gross yield of an investment is the total amount earned before taxes and expenses are deducted. It is expressed as a percentage of the investment amount. To calculate gross yield, divide the annual return on your investment (before taxes and expenses) by the current price of the investment.
The growth rate is the rate at which you expect an asset to increase in value. In real estate, the growth rate can refer to annual rent increases or to property appreciation.
Inflation is an increase in prices or expenses over time.
The interest rate is the cost of borrowing money, expressed as a percentage of the loan amount.
Internal Rate of Return (IRR)
Internal Rate of Return (IRR) is a financial analysis used to project an investment’s rate of return. This calculation does not consider external factors, like inflation, the cost of capital, or financial risk.
Investment Waterfall (Distribution Waterfall)
The investment waterfall (also called a distribution waterfall) is the method of passing profits or losses along to investors in such a way that the investment sponsor takes the brunt of the risk in the investment. Waterfalls can be structured in different ways and will be clearly outlined in the terms of your investment agreement.
Liquidity is the ease with which an asset can be converted to cash. Intangible investments like mutual funds, stocks, and bonds are highly liquid while tangible assets like real estate and collectibles are less liquid.
In real estate, an LLC (Limited Liability Company) is a legal entity that allows investors to buy and own real estate. Rather than owning the real estate in one’s own name, the real estate is owned by the LLC, which limits the liability of the owner(s).
Loan-to-Cost (LTC) Ratio
The loan-to-cost ratio compares the cost of financing a new real estate development with the cost of building a new development. This is used to determine the risk involved in issuing a construction loan to a real estate developer. The LTC ratio is calculated by dividing the loan amount by the total estimated construction cost.
Loan-to-Value (LTV) Ratio
The loan-to-value ratio shows how much of a property is financed as a percentage of the property’s current value. LTV is used to calculate the equity in a property, which is needed when refinancing a mortgage loan. LTV is calculated by dividing the loan balance by the current fair market value of the property.
A multi-family home is one building that contains several individual units, providing a living space for multiple families. Each unit has its own address. A home with two to four units is considered to be residential multi-family, while one with five or more units is considered to be commercial multi-family.
The net profit is the amount earned after all expenses are paid. Net profits are calculated by subtracting all expenses related to an investment from the total revenue of the investment.
Net Operating Income (NOI)
Net operating income (NOI) is the income that is generated annually from an investment property after you deduct the property expenses. NOI is calculated by subtracting operating expenses from income.
Operating expenses in real estate are the costs associated with running a property. These costs include insurance, utilities, property taxes, property management fees, repairs, and maintenance.
Ordinary income is a tax-related term used to classify any income that is taxed at standard rates (as opposed to income that is taxed at special rates, like long-term capital gains). Ordinary income can be wages, salaries, commissions, rents collected, tips, bonuses, or interest.
Passive income is the general term for money earned without trading your time for pay. In real estate, rental income is considered passive income because the rents collected do not require you to invest a certain amount of time or work on the properties. Interest income is another common form of passive income in real estate. And with a real estate syndicate like Gatsby, all investment income can be considered passive because Gatsby handles all the renovation/development/management for you.
Profit is revenue minus expenses. In real estate investment, profit is a property’s sales price minus all the expenses associated with buying, holding, and selling the property.
Ready-to-Issue (RTI) Permit
RTIs are the permits needed in order to build residential real estate in Los Angeles County.
Real Estate Syndication
Similar to crowdfunding, real estate syndication is when multiple people invest in a property together. With your money pooled, you can access higher-value projects that would otherwise be out of reach. A real estate syndication has a syndicator/sponsor that is in charge of finding, purchasing, managing, and selling the property, so the investors can benefit from the ownership without doing any of the work related to the investment. Unlike traditional crowdfunding, the investors of a syndication project own a stake in the underlying real estate.
Refinancing is when the existing mortgage is replaced with a new mortgage under more favorable terms. Refinancing is often used to get a lower interest rate or turn a property’s equity into cash-in-hand through a cash-out refinance.
A rent increase is when the rental rates on a given property go up compared to prior months or years. Rent increases can be expressed as a dollar amount (i.e. the rent increase will be $200 per month) or a percentage (i.e. the rent increase will be 5%).
Rental income is the money landlords or real estate investors receive from tenants in exchange for their use of the property.
Residential Real Estate
Residential real estate is any property that is zoned for single-family homes or multi-family homes of up to four units. Multi-family homes of five or more units are considered commercial real estate rather than residential real estate.
Return on Investment (ROI)
Return on Investment (ROI) is your profit, expressed as a percentage of the amount you invested. To calculate your ROI, divide your net profit by your total investment amount.
Return (more commonly called profit) is revenue minus expenses. In real estate investment, profit is a property’s sales price minus all the expenses associated with buying, holding, and selling the property.
An ROI calculator is a tool used to calculate estimated or actual returns on an investment.
Securities and Exchange Commission (SEC)
The SEC is an American government agency, intended to protect investors by regulating certain investment types like stocks, bonds, and mutual funds.
SEC Rule 506c
SEC Rule 506c allows organizations to solicit the general public for investments that are not regulated by the SEC as long as the organization meets certain requirements
. These requirements include making reasonable efforts to verify that all investors are accredited.
A single-family home is a structure with a living space intended for only one household. Single-family homes have one address.
A sponsor is a person or organization responsible for managing a real estate syndicate. This entity will purchase the real estate on behalf of the investors, manage the renovation or development, oversee any ongoing management of the property, handle the sale of the property at the appropriate time, and make disbursements to the investors as appropriate.
A vacancy rate is a metric that measures a lack of paying tenants. In the case of multi-family properties, vacancy rates are expressed as a percentage of units that are without a paying tenant. For example, a 10-unit structure with 9 occupied units would have a 10% vacancy rate since one unit is unoccupied. Vacancy rates can also be expressed as a percentage of time that a property is without a tenant. To calculate the vacancy rate in terms of time, divide the number of days a property is not occupied by the total number of days in the period (the period could be a month, quarter, year, or total amount of time an asset was held).
Zoning dictates what kind of structure can be built on a given lot. A large apartment complex, for example, cannot be built on a tract of land zoned for single-family homes.