Real estate investment has become increasingly popular in recent years. However, there are many key terms and concepts that are important to understand when getting started in real estate investing. In this article, we will provide an overview of some of the most important real estate investment terms, including investment property, REITs, net operating income, capitalization rate, funds from operations (FFO), and more. Having a solid grasp of these real estate concepts is crucial for evaluating potential real estate investments and making informed decisions. With a better understanding of real estate terminology, investors can set themselves up for success when venturing into the world of real estate investing.
Investment property refers to real estate purchased to generate rental income or appreciation.
Investment properties are those not used as a primary residence, and generate some form of income such as dividends, interest, rents or royalties. Investment properties can be residential like rental homes, apartments and condos, or commercial like office buildings, hotels, warehouses and retail centers. The use of the property has a big impact on its value. Investors may conduct studies to determine the optimal and most profitable use of a property, known as its highest and best use.
REITs allow individual investors to access large-scale real estate investments.
A real estate investment trust (REIT) owns, operates or finances income-generating real estate. To qualify as a REIT, a company must distribute at least 90% of its taxable income as shareholder dividends. REITs provide a way for retail investors to participate in real estate and infrastructure investments. Major types of REITs include equity REITs that own and manage properties, mortgage REITs that finance real estate, and hybrid REITs with both characteristics.
Net operating income is a key metric for analyzing real estate investments.
Net operating income (NOI) measures the profitability of an income-generating property investment. It equals real estate revenue from rents, minus operating expenses like maintenance, utilities and taxes. NOI excludes mortgage payments, capital expenditures and depreciation. Tracking NOI over time shows the financial health of a property and helps assess capitalization rate and value.
Capitalization rate compares property NOI to its market value.
The capitalization rate (cap rate) is the ratio of a property’s NOI to its market value. It measures the expected rate of return from a real estate investment property. Cap rates help investors estimate the potential value or price of a property based on its NOI. Lower cap rates tend to reflect less risk and more competitive real estate markets.
Funds from operations is a key earnings metric for REITs.
Since depreciation distorts net income for real estate companies, funds from operations (FFO) is an important earnings measure. FFO adds depreciation back to net income to better show cash flow from operations. REITs report FFO per share instead of EPS. FFO helps assess underlying earnings power and compare REIT valuations.
In summary, understanding key real estate terminology like investment property, REITs, NOI, cap rate and FFO is essential for proper analysis. Mastering real estate investment terms enables informed decision making.