I am not a realtor or broker nor do I pretend to be, but I am surprised by how many people assume that you need to have one of those titles to dip your feet into the real estate investing pool. Real Estate is a smart investment. I’m not the first person to say this, and I am sure I won’t be the last. Having said that, if you are new to it like if you were new to any venture, you need to do a bit of research. I think the biggest barrier for first-time investors becomes not having a proper understanding of the language and terms used surrounding investment properties, so I hope to provide a bit of clarity.
As Ken Horst explains, PITI or the Principal, Interest, property Taxes and Insurance “is basically the “bottom line” or the minimum you need to calculate when thinking about purchasing an investment property with a loan.” These components essentially act as the parts of a mortgage. By calculating your PITI, it helps to generate a rough estimate of how much capital you need to afford the property. Like most investment calculations, there are a few variations. Some mortgage programs don’t include interest or taxes. Make sure you know what your lender stands on this, so payments aren’t mishandled.
Real Estate Owned or REO predominantly refers to bank-owned foreclosure properties. Knowing whether a bank or financial institution owns a potential investment is important because there’s no emotional attachment if the institution has even seen the property and as a result, the negotiation typically plays out a bit differently. That being said, there are some obvious pros to this approach. As explained on RealtyShares, “The lender may be highly motivated to sell the property. If that’s the case, you would have a bargaining chip of sorts when it comes to negotiating things like the final purchase price and closing costs.” The lack of emotional attachment helps you avoid any emotionally driven negotiations.
NOI & DCR
NOI stands for Net Operating Income. While cash flow accounts for the general back and forth that is invested into maintaining a viable operation or the profit brought in as a result of the said operation, NOI accounts for the profit after operational costs. After subtracting all the monthly expenses associated with a rental operation, the Net Operating Income total remains. As Matt Faircloth says, “For larger deals, you want to see a NOI that is between 40 and 50% of the Net Rental Income.” Then your rental profits can account for more of the initial investment while also covering the payments associated with PITI. NOI leads us to the next term.
DCR or Debt Coverage Ratio confirms whether or not the NOI brings in enough profit to cover the debt. As James Kobzeff explains, “DCR is a ratio that expresses the number of times annual net operating income exceeds debt service (i.e., total loan payment, including both principal and interest).” Lenders use these two numbers when developing loans for income-generating property investments.