Real Estate is a multifaceted industry comprising Commercial, Residential, and Industrial properties and projects. It is central to the US Economy and one of the most common ways Americans build wealth. Real Estate Investors benefit from steady growth and less volatility compared to the stock market. Not only is it a significant investment, but it also stimulates economic activity through construction, finance, insurance, and legal services. It also creates jobs for millions who work as agents, brokers, contractors, property managers, and developers in the ever-booming Real Estate Market.

However, real estate isn’t free of its drawbacks; home prices and rents have inflated at a faster rate than wages, creating an affordability crisis and economic inequality. Real Estate is an illiquid asset, and the 2008 housing crisis proved that even real estate investments are not free of volatility. Despite the 2008 housing market crash, which seems like a nightmare that’s only just released its hold on Americans, Real Estate is the single largest asset class in the U.S., with its worth estimated to be over $50 trillion! In essence, real estate value is more than double the size of the U.S. stock market!

These numbers represent what real estate is to the U.S. economy and personal wealth. If these numbers are making you lean towards real estate investments, you’d have to glance over a few real estate terms and definitions that are crucial to being an Investor in the sector.

It’s worth mentioning that real estate accounting and taxation are some of the most complex requirements that need a professional touch. Profitjets is renowned for its proficiency in real estate accounting and can undertake your comprehensive bookkeeping and accounting needs for the best Industry prices.

Table of Contents

Real Estate Investment Terms

1. Appreciation:

The increase in the value of a property over time, driven by factors like inflation, property improvement, or an increase in demand. For example, a property purchased at $5000 in 2020 is currently valued at $5500; the property has appreciated by $500.

2.  Cap Rate (Capitalization Rate):  

A measure used to calculate the return on investment without factoring in debt. It’s used to compare investment properties. A higher Cap Rate indicates higher return and risk.

Formula: Cap Rate = Net Operating Income ÷ Value of the Property

3.  Cash Flow:

The cash earned from a rental property after deducting all expenses. Positive cash flow indicates an operating income in excess of costs, i.e., operationally profitable.

Formula: Cash Flow = Rental Income – Operating Expenses – Debt Service

4.  Debt Service:

The total debt payments on outstanding debt due for a period (monthly or annually). It includes both the principal and interest elements. It’s used to calculate the cost of debt financing and to calculate the Debt Service Coverage Ratio (DSCR)

5.  Equity:

Value represents the owner’s stake in a property. It is calculated by subtracting the mortgage due from the property’s market value. The owner’s stake increases in value as the market price appreciates, and the mortgage portion reduces with time.

6.  Foreclosure:

Failed debt servicing (mortgage payments) leads to the lender legally seizing ownership of the property. The lender typically sells the property to earn the remainder of the debt payment. This could occur due to financial hardships or recessions.

7.  Homeowners Association (HOA):

A smaller community within a community of homeowners (such as an apartment complex or a group of condominiums) that regulates the rules of using the shared space and oversees maintenance activities, like landscaping. Homeowners are typically expected to pay a monthly or annual fee.  

8.  Leverage:

Financing a property through debt enables investors to purchase more with less of their funds. It boosts potential earnings but comes with the risk of losses.

9.  Property Management:

A professional service you can hire to manage the day operations of a property. It includes several tasks like screening for potential tenants, rent collection, taking care of maintenance, etc. It is suitable for property owners who don’t reside in the area or owners who have several properties.

10.   Return on Investment:

A measure of profitability. It is obtained by dividing the net profit by the investment value (the total purchase price) and representing it as a percentage. It helps investors make property comparisons and informed decisions.

Formula: ROI = (Net Profit ÷ Investment Value) × 100

11.   Turnkey Property:

A fully renovated project that is ready to move in or rent. Potential buyers must make close to ‘0’ efforts to put the project up for rental income after purchase quickly. Property managers typically manage such projects.

12.   Depreciation:

A non-cash deduction recognized by the IRS as a deductible expense, depreciation helps property owners recoup the investment in their property over time. It’s worth noting that a property can be depreciated, but not the land it’s on. As per the IRS guidelines, Residential properties depreciate over 27.5 years.

13.  1031 Exchange:

The IRS encourages reinvestment in real Estate through a tax-deferred guideline that allows real estate investors/homeowners to sell one investment property and purchase another “like-kind” property without having to pay capital gains taxes immediately. It’s important to note that this benefit is subject to strict IRS rules and timelines.

14.   Flipping:

It involves purchasing a property with the intention of reselling it for a profit. It involves quick renovation and prompt execution to achieve a profitable sale. It is riskier than holding an investment for an extended period.

15.   Real Estate Owned (REO):

We learned earlier about foreclosure (Term 6). REO represents a property that has gone through foreclosure and is available for sale at a discount by the bank or lender. These properties are not renovated, and they may need substantial repairs and a thorough legal examination. If they are free of legal hassles, they may be a viable investment opportunity.

16.   Section 8 Housing:

This is a federal initiative aimed at providing housing assistance to low-income tenants through rental subsidies. While tenants pay a portion of the rent, the government disburses the rest directly to the landlord. The property is subject to inspection, followed by an approval process.  

17.   Amortization:

The systematic process of servicing a loan over time through installment payments that include both the principal and the interest elements. The real estate industry mortgages are usually amortized over 15–30 years. Each payment incrementally decreases the outstanding loan balance.

18.   Due Diligence:

Refers to the research and investigation period before making a property investment. This extensive procedure involves inspections, title verifications, legal standing, financial assessments, and zoning checks. It helps potential buyers avoid costly surprises after purchasing the property.

19.   Rent-to-Value Ratio (RTV):

This is a measure of rental income in comparison to property value, expressed as a percentage. It is calculated to assess the return on rental properties. Real estate investors expect a standard of 1% or higher.

Formula: RTV = Monthly Rent ÷ Property Value

20.   Down Payment:

The upfront payment made while purchasing a property. It may range from 3% to 20% of the purchase price. The down payment affects the loan amount, interest rate, and mortgage insurance.

Conclusion 

While the real estate market presents a lucrative opportunity for long-term investment and a few short-term strategies for a handsome profit, it’s essential to understand that it comes with its own set of complexities and risks. One such complexity is real estate accounting and tax compliance. It comes with several guidelines about revenue recognition, expense classifications, stringent deadlines to achieve deferred tax benefits, and the consolidation of financial statements of different real estate projects. A substantial investment in software and a trusted professional with the right expertise are needed. Profitjets is a renowned firm that specializes in outsourcing bookkeeping, accounting, CFO services, tax advisory, and compliance. You can trust us to meet your real estate accounting needs proficiently at the industry’s best prices.

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