For new investors, it's easy to get overwhelmed by facts, figures, formulas, and different investment calculations. And, although many people are aware of condo investing terms, they have trouble defining them or deploying them properly.
Our goal today is to demystify the most important condo investing terms that you need to know. This will not only make you a better investor, but it will help you impress your boss at the next company meeting.
Although there are many different types of real estate investing, the fact is that there are several key terms that every condo investor should know.
Lucky for you, we've compiled them here in a handy list. Think you know them all? Keep reading and see!
Key Condo Investing Terms #1 - Return on Investment (ROI)
ROI, or return on investment, is an important formula to gauge how an investment performs. It's a simple, quick calculation – easily done on a napkin – that lets you know how profitable an investment is.
The formula looks like this: ROI = (gain from investment – cost of investment) / cost of investment
For example, after four years you decide to sell the downtown Toronto condo you invested in. You bought it for $350,000 four years ago with a 20% down payment, or $70,000. It appreciated at an annual rate of 5.82%, which is the compounded annual growth in Toronto over the past 30 years. So that means your condo is now worth $440,127.
Let’s assume you sell it for $440,000 and have a remaining mortgage balance of $250,000. Your gain on investment is therefore, $190,000.
You also had expenses, including closing costs and upgrades, totaling $20,000. So your cost of investment is your down payment plus expenses, for a total of $90,000.
Now, let’s put these numbers into the formula:
ROI = (190,000 – 90,000) / 90,000
ROI = 100,000 / 90,000
ROI = 1.11
ROI = 111%
Over four years, your return on investment is 111%. That’s not bad! Some investors set a standard ROI they aim for and won’t buy anything that yields less than that.
Key Condo Investing Terms #2 - Pre-Construction Appreciation
One of the many reasons real estate is a great investment vehicle is long-term property appreciation. But, condos have a second opportunity for appreciation, through the wonders of pre-construction appreciation.
When you buy a condo before it's constructed, you are paying today's prices for a condo that won't be constructed for several years. That means when your condo is move-in ready and you actually buy it (take out a mortgage), it's already appreciated.
We won't get into greater detail about the merits of pre-construction condos just now, as we have a lot more juicy stuff about this to share with you in the weeks to come.
Key Condo Investing Terms #3 - Net Operating Income (NOI)
NOI, or net operating income, like ROI, is a great tool for calculating how profitable your properties will be. Although it may sound a little technical, the formula is actually quite easy:
NOI = Revenue – Expenses
This is an annual calculation and assumes you own a property free and clear. Expenses include all your operating expenses such as taxes, insurance, utilities, maintenance, etc.
Imagine you bought a property that produces $21,600 per year in rent ($1,900 per month). Your monthly expenses include the following: property taxes at $200, condo fees at $150, and insurance is $50. This is $400 a month, or $4,800 yearly.
That would mean that your NOI = 21,600 – 4,800 = $16,800. Calculating the NOI is an easy way to compare properties and maximize your cash flow.
Key Condo Investing Terms #4 - Capitalization Rate (Cap Rate)
Now that you know how to calculate the NOI, we can move on to something a little more complicated. The cap rate is another way of calculating the rate of return on your investment properties.
Although this formula is expressed as a percentage, many investors use only the number when referring to a cap rate. For instance, "the condo one of my clients just sold had a 5 cap!"
Here's how it works: Cap Rate = NOI / Current Market Value
So let's use the NOI we calculated earlier – $16,800 NOI. And, let's assume a $350,000 market value of your condo investment.
So, your cap rate = $16,800 / $350,000 = 0.048
Expressed as a percentage, your capitalization rate is 4.8%, or a respectable 4 cap! This calculation is a great way to compare investment opportunities.
Key Condo Investing Terms #5 - Refinancing
Refinancing is a crucial part of all real estate investing, and can save you thousands of dollars per year. Like most other investing concepts, refinancing seems a little scary if you're not familiar with it, but it is a very straight-forward process.
Refinancing is simply negotiating a presumably better interest rate and/or terms for your property. It is usually done for one of two reasons: either to get a better interest rate, or to free up capital for your next investment. And the beautiful freeing up capital for your next investment, is that you can pull it out free of capitals gains by refinancing. Capital gains aren't actually realized until the property is sold, whether that is in 1 year or 100 years.
We'll be going deeper into detail about the power of refinancing. In the meantime, consider talking to a mortgage broker to see if your properties are worth refinancing.
The above list of condo investing terms is by no means comprehensive. But, these five terms are some of the most important you need to know as a condo investor.
If you're consistently putting these concepts into practice, you'll be in a much better position to analyze and evaluate your existing and future condo investments – which, in turn, means more money in your pocket.
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