Glossary:  Terms & Definitions

 

Terms and their definitions are arranged alphabetically.  Where appropriate, nuances related to the Lexington-Fayette County area are described.

 

TERM DEFINITION
1031 Internal Revenue Code, Section 1031, describes conditions whereby you can defer capital gains taxes owed on income-producing or investment property by exchanging the property for "like-kind" property.  Working with 1031 requires employment of a qualified intermediary to hold your sale money while you look for another property to purchase.  As long as you put the money from a sale back into a qualified property within a specified time limit (45/180 days), you may defer paying capital gains tax on the sale.  Many companies provide intermediary services, but select your intermediary carefully to minimize your risk.
Cap Rate

Capitalization Rate (Cap Rate) lets you know how much money your investment makes compared to how much you invest.  It tells you whether or not owning a building will make you significantly more money than simply investing in stocks or CDs.  If your Cap Rate is little more than the annual yield of a good stock investment, you should either select another building, negotiate a better price or go to your stock broker and buy stock certificates.  Click here to see a sample Cap Rate calculation.

Cash Flow Simply put, Cash Flow is the amount of usable cash your investment delivers per unit time.  When asked if your investment "flows," you should be able to say "Yes," meaning that the property throws off enough money each month to pay expenses, your mortgage, and still deliver an amount to your pocket exceeding an investment in paper, such as a stock certificate or a certificate of deposit (CD) would deliver.  If not, you need to either decrease expenses, increase income or find a better investment.
Fair Market Rent Fair market rent is the rent tenants are paying for accommodations similar to yours.  You can make some assessment of the market by scanning the newspaper classified ads under your rental category, perusing supermarket property rental guides, talking to realtors, or the best way, go visit some properties and see how your units stack up against the competition -- then decide what the fair market rent is for you.
NOI Net Operating Income (NOI) tells you how much money your property generates beyond the expenses necessary to operate it.  Click here to see a sample NOI calculation.
Occupancy Rate See Vacancy Rate, below.
Pro Forma The "pro forma" describes your prospective property financially, including rental income, expenses and NOI.  Remember, this document has been prepared by the seller, usually with optimal numbers.  Look for actual rents and actual vacancy rates, for example, rather than theoretical best-case data.  The latter reflects the potential of the property, while the former reflects its current reality.
PVA Property Value Assessment, an arm of local government tasked with appraising property at a fair market value in order to tax it.  In Lexington, multi-family property is re-appraised every four years, but automatically re-appraised when you purchase it, usually at the strike price.  If buying in an area of Lexington that has not sold a property recently, you could find yourself at a market rent disadvantage with your neighbors if you purchase in year three of the four year tax re-appraisal window, for example.  You may have significantly higher taxes to cover with your rents than your neighbors do with theirs, and your rents are essentially frozen at your neighbor's market level.  Your insurance premium will likely be higher than theirs, also.
Rent Roll A rent roll should list each apartment in the property, the current tenant and the current rent.  Additional information would be lease expiration dates and additional income, such as pet rent.
Strategies for Investment Investment strategies come in two basic flavors:  Hold or Flip.  Of course, there are endless combinations.  Selecting, buying and managing a property for long-term ownership can yield a relatively steady income and relatively predictable cost of ownership over a long period of time.  This may be just the approach for someone who needs to shelter money against taxes or wants an independent source of income for retirement or to augment/diversify current income.  On the other hand, "flipping" describes the process of buying a (probably) underperforming property, fixing it up and putting it back on the market at a new price reflecting its increased value.  For a single family house, a flip may span a few months, but for larger properties, the time span usually covers a minimum of one year, often extending into two, three or even four years.  The potential long-term income for flipping properties generally exceeds that of holding properties; however, fix-up costs and risk increase when you choose to buy and flip.
Vacancy Rate Vacancy rate is the compliment of Occupancy Rate.  Simply stated, vacancy rate reflects the number of empty units a property has had over a period of time, usually a year, versus the number that could have been rented in a perfect world.  Expressing vacancy rate over a year or more smoothes out the statistical ups and downs of seasonal tenant movements and other factors.  Vacancy rates will exist for all properties.  Typical vacancy rates can range from 3 percent in extraordinarily performing properties to 30 percent or more in extraordinarily underperforming properties.  Something in the 5 to 15 percent range is pretty believable.  Click here for an example vacancy rate calculation.