Glossary: Terms &
Terms and their definitions are arranged
alphabetically. Where appropriate, nuances related to the
Lexington-Fayette County area are described.
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.
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
Click here to see a
sample Cap Rate calculation.
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
Fair Market Rent
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.
Income (NOI) tells you how much money your property
generates beyond the expenses necessary to operate it.
Click here to see a sample NOI
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.
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
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.
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
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
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
for an example vacancy rate calculation.