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You’ve probably heard that real estate is the most popular asset among Self-Directed IRA (SDIRA) investors. After all, it’s an investment that most investors are somewhat familiar with. If you’re new to the real estate investing landscape, there are some terms that will aid in your understanding.
Here are 10 terms you should know if you want to invest in real estate:
A pre-approval letter is a document provided by a bank that assures home sellers that you can secure a loan when needed. It also determines how much you’ll be able to afford.
Net operating income (NOI) is the income generated annually after property expenses are deducted.
The internal rate of return (IRR) measures a property’s long-term profitability. It takes into account its annual net cash flow and change in equity over time. It’s the best way to predict the investment’s performance during the time you’ll hold it, and is a valuable tool when comparing potential investments.
The cap rate, or capitalization rate is the ratio of net operating income produced by the investment property to its capital cost or current market value. It refers to the rate of return expected from an investment property.
Sometimes referred to as “CapEx”, capital expenditures are major renovations or new purchases that extend the life of a property. A new roof for instance is a serious, costly renovation that will increase the property’s longevity.
A non-recourse loan is a type of debt that is secured only by the asset offered as collateral. The lender has “no recourse” to seize other assets if you default on payments.
Similar to a non-recourse loan, a hard money loan uses the property being paid for with the loan as collateral. These loans are typically made by private individuals or companies willing to take on what is considered a more risky venture. Hard money loans often come with higher interest rates and a significantly faster turn-around rate than other loans.
Gross rental yield is a quick method of calculating annual ROI (return on investment). It’s the total income generated by a property divided by the price paid for it (including closing costs), prior to deducting operating costs.
Partnering is a way to generate additional funds for your real estate investment. Your IRA can partner with any IRA to purchase a property. The partnered IRAs share in the rental income and expenses, according to their percentage of ownership. You also have the option of partnering with non-IRA funds to make your investment.
The debt-to-equity ratio is a measure of ownership. It compares the amount you’ve invested with how much you owe (if you have a mortgage) to paint a picture of how much of the investment you own and what you’d walk away with if you chose to sell.
Now that you have some terminology down, you’re probably curious about what the process of investing in real estate with a SDIRA is really like. Check out 5 Steps to Investing in Real Estate With a Self-Directed IRA to learn more.