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What is "Real Estate Investing?"

What is Real Estate Investing?

Anyone can do it, not everyone will.”

- Gary Keller

Real estate investing is a broad concept. Generally, real estate investing refers to the buying, selling, leasing, renting, or otherwise acquiring rights in real estate for the purpose of generating income.[1] Real estate is one of the five basic asset classes and is generally advised that anyone looking to create a balanced portfolio invest in some form of real estate.[2]

A 2019 Gallup poll found that 35% of American respondents say real estate is the best long-term investment option; while 27% say stocks.[3]

Some Basic Real Estate Investing Terms

Before we dive too deep into real estate investing strategies, it is vital to understand the real estate investing lingo; below are some of the most common terms you may encounter.

1. Capitalization Rate.

A capitalization rate is commonly referred to as a “cap rate.” A cap rate is used to measure the annual rate of return on a real estate investment property. To calculate a property’s cap rate, use the following formula:

Net Operating Income (in the first year) ÷ Purchase Price

2. Net Operating Income, A.K.A. “NOI.”

The net operating income is commonly referred to as “NOI.” NOI is used to measure a real estate investment property’s potential to be profitable. To calculate a property’s NOI, start by first estimating the property’s revenue and then subtracting all reasonably necessary operating expenses (repairs, maintenance, property taxes, HOA fees, etc.). Keep in mind that NOI does not include loan payments.

Revenue - Operating Expenses = NOI

3. Cash Flow.

A property’s cash flow is the amount of money you pocket at the end of each month, after all operating expenses (including loan payments) have been paid. To calculate a property’s cash flow, use the following formula:

Gross Income - Operating Expenses - Loan Payments = Cash Flow

4. Holding Period.

A holding period is the duration of time between the acquisition of an investment property and its sale. The holding period begins on the day after the asset is acquired and concludes on the day the asset is disposed. Investors may hold an asset for an extended period so that they are taxed on the profits at capital gains tax rates rather than regular income tax rates. An asset held for less than one year will incur ordinary income taxes. An asset held for one year and a day or more will incur long-term capital gain taxes.

5. Closing Costs.

Closing costs are the fees and expenses paid at the end of a real estate transaction (“closing”). Closing costs vary depending on the location of the property, the type of property purchased, and the type of loan used to purchase the property. Closing costs typically run between 3-5% of the purchase price and include costs associated with title insurance, attorneys’ fees, appraisals, transfer of title, loan origination fees, inspection costs, and taxes.

6. Holding Costs.

Holding costs, also referred to as “carrying costs,” are reoccurring fees and expenses associated with owning a property. Typical holding costs include the following:

· Mortgage Payments

· Insurance

· Property Taxes

· Utilities

· Homeowners Association (HOA) Dues

7. Cash on Cash Return.

Cash on cash return, also referred to as the “equity-dividend rate,” is a property valuation formula that calculates the ratio of cash earned to actual cash invested on a property. To calculate a property’s cash on cash return, use the following formula:

Net Cash Flow (Pre-Tax) ÷ Actual Cash Invested = Cash on Cash Return

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