Investors Basic Terminology

Otherwise know as Alphabet soup or acronym heaven.

HUD / VA / REO.

These are all fancy ways of saying foreclosure. Someone stopped making there payments and the bank took the property back. The difference is the type of loan that was foreclosed. HUD (Housing and Urban Development) is an FHA loan, VA (Veterans Affairs) is a VA loan, and REO (Real Estate Owned) is a Conventional loan.

Types of Loans.

FHA, VA, Conventional: Financing is critical to investors, there are a lot of financial products out there but be careful who you work with. At the basic level for most bank financed residential transactions we have 3 dominant players. (Not including hard money lenders or other mezzanine finance options) These players are FHA, VA and Conventional.

  • FHA:  Backed by the government these loans are designed for new home buyers, they have easier qualifying standards and lower down payment requirements.
  • VA:  Available only to military veterans these programs are similar to the FHA in the looser qualifying standards and lower down payments.
  • Conventional:  Regular bank loans. Higher down payment requirements right now but can offer some of the lowest interest rates. Normally the only option of the three open to investors.

Terminology.

  • PITI:  Principle, Interest, Taxes and Insurance. Any time you escrow the monthly payment that the bank quotes you is what we call a PITI payment. Teaser rates online that mention $200 a month for a $200,000 mortgage are frequently quoting you for just the Principle and Interest. As we all know in Texas the taxes take up quite a chunk and they don’t go away. Generally, unless you are putting down at least 20% the banks don’t give you an option. However, as an investor it’s sometimes preferable not to escrow. For example, if you are holding short term not escrowing can reduce your holding costs and you pay taxes at closing. Personally we like earning the interest (no interest in escrow accounts) although it is hard to write those checks at the end of the year. However, if you can’t keep a budget don’t risk it. You have to be able to put aside the $5,000 or more a year.
  • GSI:  Gross Scheduled Income = How much money a property makes per year.
    •  Example:  $1,000 per month = $12,000 per year GSI
  • NOI:  Net Operating Income = GSI minus operating expenses. (property tax, utilities, management, maintenance) Normally also calculated average local vacancy rate or 10%.
    • Example:  $12,000 per year - $4,800 operating expenses - $1,200 vacancy rate = $6,000 per year NOI
  • Cashflow:  NOI minus any debt service like a bank loan.
    • Example:  $6,000 - $3,000 (Principal + Interest) = $3,000 yearly Cashflow
  • GRM:  Gross Rent Multiplier = The price of a property divided by the current annual gross scheduled income of the property. If you mess with stocks this is like the P/E ratio. A lot of factors play into the calculation but the bottom line is a lower number is good because in general that should equal a lower purchase price and greater cashflow.
    • Example:  Purchase price = $100,000 divided by GSI of $12,000 = GRM of 8.3
  • CAP Rate:  The net operating income divided by the purchase price. The Cap rate is designed to tell you what you would make pre-tax if you paid all cash for the investment. In comparison most corporate investors have been happy to get 6% to 7% with REITs (Real Estate Investment Trust) over the last few years.
    • Example:  (i.e. $100,000 purchase price divided by an NOI of $10,000 = 10% cap rate
  • Cash on Cash return: The first years pre-tax cash flow divided by initial invested dollar (Your down payment + closing costs).
    • Example:  Purchase price of $100,000, down payment of 10% or $10,000, with 1% financing fees = $11,000 invested dollars, if the property cash flow is $1,100 then you have a 10% cash on cash return (Remember your cashflow is your NOI less your debt service).

These are the basic phrases you are likely to here. These formulas allow you to objectively evaluate the investment but they each have limitations. They do not take into account tax benefits/costs of investment property which are major factors to determining profitability. In addition, the above formulas do not take into account investment property appreciation (property increases in value) or depreciation (government allows you to decrease properties worth and write off as loss) both good things for the investor.

One other important word in the investment vocabulary…Taxes.

Taxes are the largest expense you will pay in your life. They directly and significantly impact the profitability of your investments. We here at the AustinHouseHounds are not tax experts. We happily pay for a professional to take care of this burden for us. We recomend you make sure you have a good CPA who knows the correct wrightoffs and tax advantaged strategies associated with real estate investment. The CPA will more than pay for himself/herself.

Our investment background.

In the last year we’ve created multiple LLC (Limited Liability Corporations) for the purpose of investing in real estate. Last year we made $75,000 for ourselves and our partners.

We watch the market all the time. We work in real estate how can we not. Call us when you are ready to get started.

Foreclosures:

People love RealtyTrac and Foreclosure.com because they look at this as a way to find deals. Most of these properties are below market but that doesn’t make them great deals. You have repair costs, holding costs, and neighborhood problems that could easily lead to you loosing money.

We do find deals here. We work both pre and post foreclosure properties on a regular basis. The difference is that generally we know what we are buying beforehand.

We also love the TV shows about real estate. These people make $75,000+ every time. The problem is 1) We’ve never found decent contractors willing to work as cheaply as they quote, 2) We have no idea how they are coming up with there resale price and 3) If you make $75,000 in under three months you will write a $25,000 check to the tax man for short term capital gains.

You don’t only have to stick with the post foreclosure property listings. You can pick up properties pre foreclosure and on the auction block, often at bargain basement prices.

Pre-Foreclosure: You may see these homes show up as “short sale” properties if they are listed at all. Pros: You can negotiate directly with the homeowner, you may have fewer competitors, you get to do a home inspection, you can finance the property. Cons.: Takes a lot of time to track, homes are often listed at or above market, sellers often are not willing to admit they have a problem until it’s too late.

Auction: Sale of a home on the court house steps. Pros: Homes are often 30% to 50% below market, you have a list of homes to choose from. You are often only buying the 1st lien on the home, thereby creating instant equity. Cons: You have to have money up front (normally $100,000+) as a cashier’s check or cash, no financing. Lots of potential problems if you don’t do your homework. Clouds in title prevent resale, no home inspection means there are often issues you don’t know about, there may be litigation issues that remain with the property after the auction, if the property is occupied you get to do an eviction and many more.