Summary: Don’t let confusing lingo hold you back from generating true wealth through real estate investing! We’re breaking down some of the most important terms, abbreviations, and phrases you’ll come across as a multifamily investor – so you can feel like a pro and invest with confidence.
Have you ever tried to learn a foreign language?
We’ve been there, and wow…it can be SO hard. 😅
But you know what sometimes feels equally as hard as mastering a whole new language that is not native to you?
👉 Starting out in multifamily apartment investing, and realizing how many terms, phrases, and even calculations there are to learn!
What’s the difference between AAR and IRR?
How is a CAP rate calculated?
What the heck is NOI?
Why do most lenders require at least 1.25 DSCR?
You are so not alone if any of those questions have you scratching your head. Without understanding investor lingo, it can be hard to gain solid footing on the path towards your dreams. So, consider us your translators for today!
We’re here to make sure that NOTHING can slow you down as a multifamily investor, by explaining some of the most common investment terms you’ll come across on your journey to grow wealth and finance your future. 🙌
You will definitely learn as you go, but we hope this resource can be a lovely little jumping off point, so you can truly hit the ground running.
Ready to feel financially fluent and learn the lingo to invest with real confidence?
Let’s get started! Here are the terms we’re breaking down today:
- Net Operating Income (NOI)
- Capitalization Rate (CAP)
- Gross Potential Rent (GPR)
- Debt Service Coverage Ratio (DSCR)
- Loan to Cost (LTC)
- Economic Vacancy
- Annualized Cash Flow
- Internal Rate of Return (IRR)
- Net Operating Expenses
Net Operating Income (NOI)
First up in today’s language lesson, we’re chatting about one of the most important terms to know, especially for multifamily apartment investing deals.: net operating income.
The net operating income is what apartment syndicators (like us👋) strive to increase – either by raising the income or decreasing expenses of a property. There’s lots of strategy that goes into the task of raising the NOI, but the important thing for multifamily investors to know is this:
👉 A high NOI means that returns are maximized for passive investors.
So, this is a term you definitely want to look out for when choosing apartment investing deals.
Capitalization Rate (CAP)
Moving right along here…the next term you need to know is capitalization rate.
The CAP rate, when it comes to multifamily apartment assets, is a snapshot of the investment return BEFORE financing is taken into account.
Why is this important to know?
Well, think of it this way. You’re considering entering into a multifamily apartment syndication deal. Verrrrry exciting, right? Before diving in, you want to be able to calculate the ratio of how long it will take to make your investment back in an all-cash purchase.
Normally, you’ll be given the CAP rate by the apartment syndicators in a deal, but it’s best to know how to find the CAP rate for yourself – to be the well-informed, confident investor we know you are. 😏
So, you can calculate the CAP rate yourself by taking the NOI (which we chatted about before) and dividing it by the purchase price, AKA the value of the property.
Make sense?
Keep in mind that CAP rates, while good to know, are not set in stone. They can change throughout the course of a multifamily apartment deal.
Reason number 574,648,000 why we love multifamily apartment syndication…multifamily properties are valued based on income. This means that as the property’s income goes up, so do your cash flow returns. 💸
Gross Potential Rent (GPR)
Next up, we’ve got gross potential rent. In multifamily apartment investing, this is the monthly rent, multiplied by the number of units in the property, multiplied by 12 (months).
This number is based on 100% occupancy rates, calculated for the entire year. Yes, there is a bit of research involved here, because you need to know the going market rental rate in the area of the property ahead of time. But you’re a savvy, smart investor, and we know you’ve got this.
Just remember that as much as we love perfect world daydreaming, a full year of 100% occupancy is notttt always a reality. The GPR is important to know, as long as you stay a little flexible in your expectations, too.
Debt Service Coverage Ratio (DSCR)
The debt service coverage ratio is the current income of a multifamily apartment property (the NOI), divided by the property’s debt obligations.
This is a good equation to know, because it can tell you how much risk a certain multifamily deal involves. When the DSCR ratio is high, it tells you that you have more leverage to work with, while the lender has less risk.
Usually, a 1.25 DSCR is considered a healthy ratio for a multifamily apartment deal. Higher than that is even better, but here’s a super secret insider tip…anything lower should definitely be considered a red flag. 🚩🚩
Loan to Cost (LTC)
When you come across the loan to cost for a certain property, it’s referring to the loan amount, divided by the total cost of the property.
The LTC typically depends on several factors, but in today’s market, it’s normal to see numbers at 65-75% or higher. When it comes to minimizing your own risk as a multifamily investor, you don’t want this number to be too high. See, even though debt is cheap and useful, you still want to keep your exposure on the lower side.
After all, you never know what can happen with the market, and having a little wiggle room is a very good idea.
Economic Vacancy
Economic vacancy is a term you will definitely see in multifamily apartment syndication, because it refers to a unit that is not currently bringing in rent. Economic vacancies do not contribute any income to the property.
Now, we know this might sound like a bad thing, but it’s honestly just a normal part of multifamily apartment investing.
Not every apartment unit is going to be occupied at all times. If they were, we would actually need to make some adjustments and consider raising rent for tenants.
So, yeah. Economic vacancies should be expected by every multifamily investor. In our own multifamily deals, we usually plan for about a 10% economic vacancy rate, and factor it into our underwriting.
You mayyyy see some syndicators claiming 5-7% economic vacancy, but they are most likely just trying to make the deal sound more appealing to multifamily investors.
The Kitti Sisters don’t roll like that…not at all.
We’re all about transparency and realistic expectations. We don’t need to skew the numbers to attract multifamily investors because, well, our track record speaks for itself! 😉
Annualized Cash Flow
How are you doing…still with us on this investment language crash course?
We hope so, because this next one is pretty fun. The annualized cash flow is – to put it simply – the annual cash flow distribution that you are expected to receive. This is your net annual cash flow, divided by your equity.
Typically, the annualized cash flow for multifamily apartment deals rests between 5-7%, but this number can definitely change.
Sidenote: the cash flow for Kitti Sister properties is continuously on par with projections.
Our multifamily investors can rest easy knowing that we take everything into account when giving projections, and do everything in our power to make expectations a reality.
Internal Rate of Return (IRR)
While the average annual return (AAR) is popular for many apartment syndicators, the Kitti Sisters tend to gravitate towards the internal rate of return instead. The IRR goes a little deeper than the ARR, by taking into account the time value. The longevity of the deal matters, along with the value of the dollar in the current economy.
The higher the IRR, the faster you can expect money to return to you through cash flow distribution or selling the property.
As multifamily investors in today’s economy, security is a very important thing. The IRR enables you to make even more informed decisions about what to expect from a multifamily apartment investing deal.
The formula for calculating the IRR takes into consideration the annual distributions for investors, the date that the property will be sold, and the property’s expected selling price to find the total expected return.
Net Operating Expenses
Lastly, let’s talk expenses. The net operating expenses represent the total cost of operating expenses for a multifamily apartment property.
These expenses include all of the money that goes into maintaining an apartment complex – like property insurance, property taxes, and property management, as well as any repairs, eviction fees, legal costs, etc.
You know…all the fun stuff. 😂
And that’s about it!
We’ve covered a LOT of key terms you’ll come across as a multifamily investor, but we want to set you up with even more valuable info. That’s why we made a special, free resource for you, filled with hundreds of apartment investing terms!
You will definitely want to check out, download, and save the Kitti Sisters Apartment Investing Terms Workbook, to have on hand throughout your own apartment investing adventures!
You’ve totally got this. We’re just here to help you feel confident and prepared on your way to investment success. ✨
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