As an investor in Chicago, there are bound to be a number of real estate investment terms that you will come across that you aren’t familiar with. In our latest post, we define so of the most common misunderstood terms for Chicago real estate investors!
Misunderstanding just a few terms when making an investment can have huge impacts on your overall returns. Before making an investment in Chicago real estate, it’s important to know and fully understand the terms, acronyms, concepts, and expressions outlined below.
A 1031 exchange allows an investor to defer the capital gains taxes they could normally expect when selling a property for a profit. The 1031 exchange allows an investor to purchase a property of like kind with the profits of the sale, without first incurring taxes. There are conditions to the exchange such as the property must be of “like kind.” That said, like-kind covers a wide array of properties.
Amortization is the process of paying off your loan each month. It calculates the percentage of the principal and interest you are paying as these amounts vary month to month. Your total payment will remain the same.
ARV refers to the “after repair value” of a property. It is not what the house is worth today but rather the potential value of a property once it has been fixed-up and restored.
BPO refers to what is called a broker price option. It is a report similar to a CMA (Comparative Market Analysis) performed by a broker, licensed real estate agent, or a property appraiser. The report will contain information regarding the property and the neighborhood. This information is used to determine the value and selling price of a house.
The Capitalization Rate is used to calculate the potential profit of a property. There are some variations on this, but most commonly the rate for a property is determined by dividing the property’s net operating income by the current market value.
Capital gains refer to the increase in the value of a property over time. It is the difference between the current value and the original purchase price. The gains are not assessed and taxed until the property is sold. The taxes can be avoided when reinvesting elsewhere using a 1031 exchange.
Earnest money is a deposit made to a seller showing good-faith from a buyer. This allows the potential buyer to put a “hold” on the property while they do their due diligence and secure financing.
Equity is the difference between what you owe on the house and its current value. Let’s say the house is worth $150k and you owe the bank $50k, you would have $100k in equity for the home.
The Gross Rent Multiplier or GRM is the ratio of the price of a real estate investment to the annual income provided by the property. It will let you know how long you need to own the house before it pays for itself.
An LOI or Letter of Intent is an agreement that states the intent of an investor to buy a property. It will outline the terms that must be met before a legally binding contract is signed.
The Loan To Value Ratio or LTV is the amount of the loan vs. the value of the property you are purchasing. This ratio helps lenders calculate which loans will go through for which properties.
NOI refers to the net operating income of a property. It refers to all the revenue received by the property minus the costs of standard ownership expenses such as taxes and maintenance.
REO stands for “real estate owned” and is the term used for properties owned by banks or lenders after an unsuccessful foreclosure sale. These properties can often be purchased at a price lower than market value. However, there can be some repairs needed or other problems to the property.
A short sale is the term used when a homeowner strikes an agreement with the lender to sell for less than what is owed on the home. This helps homeowners out of tight situations, and banks recoup some of their costs. Short sale homes can be usually be picked up for a low cost, but you should use caution when making the investment.
When you begin investing in Chicago real estate, there will likely be some terms that you are unfamiliar with. When you come across something you are unsure of, make it a point to fully educate yourself on the subject. A small misunderstanding of a term can result in a large error that can affect you financially.