Real Estate Investor Magazine South Africa November 2018 | Page 66

LAST WORD
Don’t be Duped by
Real Estate Lingo
Terms you need to
know as an investor
BY EDITORIAL
R
eal estate investors, brokers, agents, asset managers
and industry professionals from financial institutions
can often forget that some of the terminology they
use is unfamiliar to those outside of the real estate industry.
Here is a three-part series on must-know real estate terms
to help you understand and manage your investments with
confidence. We unpack 5 terms you need to know that can
impact on your investments and finances.
1.Internal Rate of Return (IRR)
This is a common real estate investment term you’ll see
when browsing rental properties or crowdfunding websites.
The internal rate of return (IRR) is a measurement of a
property’s long-term profitability that takes into account
annual net cash flow and the change in equity over time.
Why it matters:  IRR is the single best estimate of your
asset’s performance over the entire time that you plan to
hold it. It allows you to evaluate investments that may have
different cash flows or appreciation potential.
2. Cash flow
Cash flow is the amount of money you can pocket at the
end of each month, after all operating expenses (including
loan payments) have been paid. If you spend less money
than you earn, your cash flow will be positive. If you spend
more money than you earn, your cash flow will be negative.
Rental income - all operating expenses (including loan
payments) = Cash flow
2. Net Operating Income (NOI)
This is a calculation for rental real estate. Easily explained,
this is how much money you would make if you owned
the property free and clear of a mortgage. The NOI is
calculated on an annual basis and equals the Net Rental
Income (total rent for the year minus vacancy), minus the
Operating Expenses (this is all costs for maintaining the
property, including real estate tax, insurance, maintenance,
management, utilities, landscaping, legal, leasing commis-
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sions, etc.—everything except the mortgage payment.)
Sometimes people include “Capital Expenses” as an
expense also. More on that later. For larger deals, you want
to see a NOI that is between 40 and 50% of the Net Rental
Income. The NOI means very little by itself, but it’s used
for two very important calculations, explained below.
3. CAP Rate (Capitalisation rate)
The Capitalization Rate is NOI divided by the sell price or
value of a piece of real estate. It is expressed as a percent-
age, but most people leave the percent part off when they
are talking about it, i.e., “This property is a 10 CAP!” CAP
rates are used to compare real estate investment opportu-
nities. The CAP Rate is what your return on investment
would be if you owned the property free and clear.
4. Cash-on-Cash Return
Definition: This figure is the ratio of annual pre-tax cash
flow to the total amount of cash invested, expressed as a
percentage. Cash-on-cash return measures the yearly return
in relation to how much money you put down. It doesn’t
take into consideration some of the other benefits of rental
property ownership, including appreciation, loan paydown,
depreciation and other tax benefits. Whereas calculations
based on standard ROI take into account the total return
on an investment, cash-on-cash return only measures the
return on the actual cash invested. It’s the cash you’ve got
left after one year, divided by the cash you’ve invested.
Annual pre-tax cash flow / actual cash invested = Cash-
on-cash return 
5. Debt Service
This is a fancy way to say “bond or mortgage payment.” It’s
the money required to “service the debt” on the property.
It includes the interest on the loan and any pay back of the
loan balance (principal reduction, defined below). The NOI
minus the Debt Service equals your cash flow.
Don’t miss part two next edition