The Language of Real Estate Investing
By Denis Shapiro
Investing in real estate can be a worthwhile endeavor, but make no mistake: It’s an entirely different world than traditional investments like stocks and bonds. A huge impediment for newer investors in the space is actually learning the terminology used in most real estate transactions. An even bigger impediment is when a newer investor is blinded by high potential returns without understanding the fundamentals behind the returns and, as a result, puts themself in a precarious position with their first investment.
In many ways, the outcome of the first deal you invest in will dictate the trajectory of your other investments in real estate. While a good deal can build your confidence and give you added motivation to continue investing, a really bad deal can leave you sour and skeptical.
After all, if an operator who promised outstanding returns couldn’t deliver, how can an operator who promises average returns do any better?
The Starting Line: Deciphering the Jargon
Understanding the terminology is only half the process in learning the language of real estate investing. The other half is the ability to understand the merits behind the terms. For example, the most used word in private real estate deals is “conservative.” It’s a term that characterizes how a business plan was modeled and what kind of assumptions were used by the operator. The term conservative is supposed to make a potential investor feel assured that there will be a wide margin of error for the deal to perform. For example, the operator may state that most of their competitors charge an additional $200 per month in rent for similar apartments, but they are underwriting the deal conservatively, where the investment will still pan out at only a $100 increase. As you vet the deal further, the operator may state that if they can hit the $200 increase at some point, then this deal’s projection will get blown out of the water. However, these statements are usually accompanied with a cautionary statement, such as, “but we’re not projecting for all that upside—thus, our conservative underwriting.”
If an investor takes the word “conservative” at face value in this scenario without digging deeper, they would have been better off never seeing the word conservative in the deal in the first place (even though it’s hard to miss because word conservative is plastered all over every investment document!). This is where the understanding the context comes into play. In our previous example, the operator’s business plan outlined increasing the rent anywhere between the conservative $100 all the way to the aggressive $200. As an investor, it’s all in the details. We need to look at the comparable rent estimates, amenity packages, where the properties are located in terms of crime levels, school districts, etc. In one deal SIH Capital Group analyzed, the operator compared two apartment complexes in a completely gentrified area with their newly acquired building in an area that was very close but still in a bad part of town—this is sometimes referred to as the “path of progress.” Even with a discounted rent increase compared to the two other buildings, pegging your numbers to the ability of a neighborhood to keep improving on par with the trends in other surrounding neighborhoods isn’t conservative.
In a hot market, the deal would probably work out, but what if the path of progress stops short and never reaches the newly acquired apartment building? This is where context comes in. Learning the language means peeling back the layers of what you’re hearing and putting the words through your own filter.
The Universal Language of Real Estate Terminology
At SIH Capital Group, we believe in the merits of alternative investments with a core focus on real estate investing. The reason is because real estate has so many offshoots that by learning the language of real estate first, it’s the equivalent of learning Latin for European dialects. Many other alternative assets—like mobile home parks, self storage, mortgage notes, industrial spaces, and more—use the same terms.
LinkedIn: A Great Place to Get Your Feet Wet
One of the biggest secrets of investing is how easy it is to get started. In fact, here is a quick step-by-step process that you can follow today—for free.
- Create a LinkedIn account and indicate that you are a real estate investor looking to connect with other investors.
- After a few weeks (if not days), you’ll routinely receive requests to schedule calls with your growing LinkedIn network.
- In all honesty, there might not be significant value in the substance of these initial calls, but they can give you vital practice discussing investment topics.
- You’ll want to scale back the LinkedIn calls as your actual organic network grows, which should include some but not all of your new LinkedIn connections.
The Top 10 Key Real Estate Terms
While your quest to learn the language of real estate will continue for months, years, and in some cases longer, here are 10 of the most common terms you’ll encounter—so they’re a great place to get started.
Capitalization rate — A multiple of what the market is willing to pay for the profitability of a business/property
Depreciation — The reduction of the value of the asset due to wear and tear
General partner — The operator of a deal that sources, manages, and executes on a business plan and usually has 100% control of operations
Internal rate of return (IRR) — A method of calculating an investment’s average rate of return factoring in the time value of money and the investments cash flow schedule
Limited partner — An investor in a deal that is usually passive in nature and has no operational authority
Net operating income (NOI) — A formula used to show how profitable a business is by subtracting all the revenue the business produces from all reasonably necessary operating expenses
Syndication — The pooling together of money to purchase a common asset. A common syndication will have a limited partner and a general partner
Sophisticated investor — Someone who has the experience, net worth, and necessary capital to be able to effectively evaluate the risk/reward profiles of more advanced deals
Preferred return — A preferred return is the hurdle that an investor needs to see in distributions before the investor starts splitting the profits with the operator
If you liked this article and wish to continue on your path in learning about alternative investments, please make sure to check out my other educational articles as well as my book, The Alternative Investment Almanac: Expert Insights on Building Personal Wealth in Non-Traditional Ways.
Disclaimer: The information presented in this article is for informational purposes only and does not constitute professional financial or investment advice. The author does not make any guarantees or promises as to the results that may be obtained from it. You should never make any investment decision without first consulting with your own financial advisor and conducting your own research and due diligence. Even though, the author has made reasonable efforts to ensure that the contents of this article were correct at press time. The author disclaims all liability in the event that any information, commentary, analysis, opinions, advice and/or recommendations contained in this article results in any investment or other losses. Your use of the information in this article is at your own risk.