Some Definitions of Real Estate Terms In Plain English

Ever wonder who writes definitions of any particular industry’s nomenclature? In baseball for instance, a little over half my time umpiring was spent doin’ the ‘dish’. The what? The dish is home plate, where the plate umpire’s main duty is to call balls and strikes. When a hitter’s at the dish lookin’ ‘dead red’, he’s up there lookin’ for nothin’ but a fastball. Ever heard of Louisiana Ball? The hitter just struck out, swingin’ late on a fastball. From the pitcher’s dugout you might hear, “That musta been some Louisiana ball, cuz that one was Bayou!” Baseball lovers know what I’m talkin’ ’bout cuz there are a million of ‘em.

Same happens in real estate investments, though its nomenclature, sadly, isn’t nearly as plentiful or colorful as is baseball’s. Here are a few terms with some plain English definitions. Some of them are formal terms, some slang. Hope this helps.

Tax Free Exchange This is an insidious, non-existant animal, as there is no such thing. When using Section 1031 of the Internal Revenue Code, you’ll be deferring your potential capital gains taxes — not escaping them. Be serious, how many times in life do we get to skate on taxes? Which is, of course, why it’s correctly known as a tax deferred exchange.

Starker Exchange Much more commonly known now as a Delayed Exchange. Those who’ve been in the business longer than a few years have heard about ‘Starker’. We can all thank the Starker family for forcing the IRS, the heavy lifting done by the Tax Court (through an appeal actually) for our presently codified ‘Delayed Exchange’. Before Starker? Every property in a tax deferred exchange had to close on the same day in the same moment in time or there was no tax deferral. It was, um, interesting the same way the Chinese mean when they wish their enemies to live in interesting times. It was rarely anything but organized chaos which almost always including generous doses of abject terror for all involved. I’ve included a link below for some rules and definitions from an earlier post on the subject.

Installment Sale Sellers will sometimes accept a mortgage for all or part of the sales price. Tax on the gain is paid as the mortgage principal is collected. Payments on installment sale notes are separated into three categories. 1) Return of principal (not taxed) 2) Return on principal (subject to capital gains taxation) 3) Interest (taxable in the year received). For the long term real estate investor, this is a tax reduction strategy, sometimes applied in concert with a tax deferred exchange. Most investors are unaware that tax deferred exchanges don’t have to be ‘all or nothing’. To use the cliché, while horribly mashing together metaphors — it’s possible to be partially pregnant when it comes to tax deferred exchanging. Sorry about mixed metaphor, but seriously, how long have ya been readin’ stuff here?

Capital Expenditure This one can cause problems for those tryin’ to be too clever by half on their tax returns. An operating expense, for instance a management fee, is deductible against the property’s rental income. A capital expenditure, a new roof for example, must be ‘capitalized’, i.e., given a life and depreciated or a finite period of years. Do not play games with these two line items, as in the end, you will lose. The IRS isn’t stoopid, and can tell the difference between repairing a few shingles or flashing and reroofing. ‘Nuff said.

Debt Coverage Ratio Often referred to as DCR. This one’s a ratio used by loan underwriters for income producing property. It’s created by dividing Net Operating Income by total debt service. NOTE: Debt service is simply the total of all your monthly loan payments for the year. Ratios of at least 1.10 are generally required with ratios of 1.20 and higher considered the norm when it comes to apartment properties of more than 4 units. A ratio of 1.0 denotes a ‘break even’ cash flow. Under 1.0 means there’s a negative cash flow.

Time is of the Essence This is a phrase, that when inserted into a contract, requires all references to specific dates and times of day noted in the contract be interpreted exactly — in its absence extreme delays might be acceptable. Most contracts insert this in the boiler plate. It’s one of the fundamental factors in any real estate transaction. Take it literally — the other side will.

Here are some terms and definitions specifically related to tax deferred exchanges, now commonly known as Delayed Exchanges.

Capitalization Rate Often made to sound way cool by just sayin’ Cap Rate. This one is one of the simplest, yet one of most often misunderstood terms in real estate investing. The definition/formula is pretty straightforward. You figure the cap rate by takin’ the Net Operating Income (NOI) of a property and dividing it by the price. For example, a property sportin’ a $10 NOI with a $100 value would look like this: 10/100 = 10% capitalization rate. It’s always expressed as a percentage. Get a whole number and you’ve screwed the pooch somewhere. Another way to look is what your cash on cash return would be if you wrote a check for the entire purchase price. A $10 cash flow would be a 10% cash on cash return AND cap rate on a $100 property if purchased for cash.

There are way more terms and phrases, but that’ll do for today. Gimma a call with any questions — none are too small. 619 889-7100 will find me. Have a good one.

Related posts:

1. Always Wonder What Certain Terms Mean? Real Estate Definitions
2. More Definitions For Real Estate Investors Tax Deferred Exchanges
3. Reviewing Some Basics — Some Real Estate Investment Terms — What’s He Mean, Gross?
4. Some Definitions For Beginning Real Estate Investors
5. Purposeful Planning And Tax Shelter For Real Estate Investing