UNDERSTANDING REAL ESTATE
Getting started in real estate seems difficult at a glance when you know nothing about it. One of the biggest barriers to entry is not understanding the terms that come with real estate investing. It's important to understand these concepts and your position in the market before getting started. Real estate is truly one of those industries that could make or break you if you don't fully understand what's going on at the start. To help you out I've created this quick guide of all the essential terms you need to know before getting started in real estate.
23 Concepts You Need to Know Before Investing in Your First Property
- Purchase Sale Agreement (PSA)
A purchase sale agreement is just a fancy term for the contract you are using to buy a property. There are other contracts out there to purchase a house and create financing but a PSA is the main one you need to know from the get go.
- Single-Family House (SFH)
A single-family is exactly what you think it is, it is considered a solo property meant for one family to live in.
- Multi-Family House (MFH)
A multi-family house is a property that has several units for multiple families to reside in the same house. Technically, to be considered a multi-family house the property must consist of more than five units.
Escrow is the process that starts after you begin your purchase sale agreement. In which the home deed will be delivered to a Title company until the home buyer completes the closing process.
- After Repair Value (ARV)
After repair value is the appraised value of a home after it has been renovated and gone through repairs for appreciation.
- J1 Contract
A J1 contract is part of the escrow process where the property undergoes an inspection period. During this period, the buyer can pull out or request to have repairs done or a credit. This contract can go by multiple names but in Hawaii it is referred to as a J1 Contract.
- Capitalization Rate
Cap rate is a widely used measurement to assess real estate investments for their profitability and return potential. It is calculated by taking your net operating income and dividing it by your purchase price. Cap rate is ultimately a measure of risk and should be used by investors as an average for the area they are operating in.
Comparables is a real estate term that is referred to as 'comps.' Comps are most often used as financial measures of other what other similar properties in the area are selling for. This metric is important for real estate investors so they can understand their market better before investing.
- Adjustable-Rate Mortgage (ARM) Loans
ARM loans adjust the interest rate on your mortgage based on the market. This allows borrowers to get better rates over time and maybe start with a lower payment on their mortgage.
- Loan-to-Value Ratio (LTV)
LTV ratio is a measurement used to compare the value of your mortgage against the appraised value of the property. Typically the higher down payment made, the lower the LTV will be and likely the interest rate will be lower.
- Loan-to-Cost Ratio (LTC)
LTC ratio is a measurement used mainly in commercial property or flipping houses and is calculated by taking the loan amount and dividing it by the construction costs.
Points is a term used for the percentage of what the mortgage lender is charging for their services. Typically you would want this to be as low as possible around 1%. If the points are above 1 then the lender is most likely using a broker for their services and it is an extra cost to you as the home buyer.
- Return on Investment (ROI)
ROI is a basic measurement used across the board for investments and its calculated by taking the value of what you put into an investment divided by the expected return that investment will provide you. This is a key metric to help investors decide if an investment is the right fit for them.
An appraisal is done on a home to evaluate the fair market value of the property. The price calculated by an appraiser is important in determining loan amounts, purchase price, and buying offers on a property.
- Appraisal Contingency
An appraisal contingency is a condition that must be met before the sale of a home. In which if the appraisal value of a home is not what a buyer agreed to pay they are able to walk away with their deposit.
- Closing Costs
Closing costs are leftover fees and expenses after a down payment is made in order to secure a loan for the property.
- Due Diligence
Due diligence is the process of deep-diving into the specifics of a property before buying to mitigate uncertainties. This means the buyer would take the opportunity to inspect the home, review financing, look into the seller, and understand compliance obligations
An underwriter is a financial expert that is assigned to work on your loan to verify your debt, income, and assets in order to approve your loan application to buy a property.
- Earnest Money Deposit (EMD)
An earnest money deposit is the money required to lock up a property under contract and into escrow. This amount is agreed upon by the seller and buyer of the property. This ensures holding costs will be covered under contract by the buyer and/or the seller will be compensated if the buyer backs out of a deal. Understanding this contract is important to know in what circumstances the buyer would not get their earnest money deposit back.
Home equity is a measurement of how much your home is worth once you subtract how much is owed on your mortgage.
Appreciation is the increase in the value of a property over time. Subsequently, depreciation is the loss of value on a piece of property over time.
Unlike buying a house outright, a leasehold only allows a tenant to have exclusive access to a property for a period of time (years, decades, or centuries).
- Fee Simple
Fee simple is the top tier of ownership, it means you own the land or any buildings on the land outright. The property is yours to be used without any limitations or conditions.
I know that was a lot of information to take in, trust me it's taken me years to digest and feel comfortable with this new language. The only way you're going to feel confident in your understanding of all things real estate is to just get started.
If you feel good about your knowledge of these concepts and that you're positioned well in the market then now is the time to start investing in real estate. You can go out and do it on your own, or work with an investor on projects to take on more of a hands off role. We work with real estate investors all the time on projects across Hawaii and the mainland.
Don't hesitate to email email@example.com with more questions about getting started in real estate. Aloha!