Navigating the world of property management and real estate investing requires more than just knowing how to buy and rent properties.
Understanding key financial terms – talking shop, in other words – can mean the difference between making profitable decisions and costly mistakes.
Whether you’re a seasoned investor or just starting, here are the finance terms you absolutely need to know:
1. The 1% Rule
Imagine you’re shopping for an investment property.
You find a house listed for $150,000, and you want to know if it will generate enough rental income to cover expenses and possibly turn a profit.
The 1% Rule provides a quick way to assess this: If the monthly rent is at least 1% of the purchase price (in this case, $1,500), you’ve found a property that meets the 1% rule.
Example Calculation:
- Purchase Price: $150,000
- 1% of Purchase Price: $1,500
- Expected Monthly Rent: $1,600
- Outcome: Since $1,600 is greater than $1,500, this property meets the 1% Rule and may be worth further analysis.
Attaining the 1% rule is now VERY difficult in Central Indiana. So, if you use the 1% rule exclusively to vet properties, you’ll likely be looking a long time.
2. Appreciation
Think of a home in a growing neighborhood. If you buy a property for $200,000 today and the area becomes more desirable over time, the value of your home may rise. Five years later, you might be able to sell it for $250,000, making a profit simply by holding onto the property.
Example Calculation:
- Purchase Price: $200,000
- Annual Appreciation Rate: 5%
- Value After 5 Years: $255,200
Take a look at the graph here to see how appreciation can raise the price of a property over $50k over only 5 years:
Appreciation is one of the most powerful wealth-building tools in real estate, but it’s not guaranteed. Market downturns can cause property values to drop, so it’s important to invest in locations with strong long-term potential.
3. Equity
Think of equity like your ownership stake in a home. If you buy a house for $250,000 and take out a $200,000 mortgage, you own $50,000 worth of the property.
Over time, as you pay down the loan and if the home value increases, your equity grows.
Example Calculation:
- Current Market Value: $250,000
- Remaining Mortgage Balance: $150,000
- Equity: $100,000
Growing equity can provide options like refinancing for better loan terms or leveraging the property to buy more investments.
4. Cash Flow
Imagine you own a rental home that brings in $1,500 a month. After paying your mortgage, taxes, and maintenance, you still have $275 left. That’s your cash flow—the money you actually get to keep each month.
Example Calculation:
- Rental Income: $1,500
Expenses (Mortgage, Taxes, Insurance, etc.): $1,225
Net Cash Flow: $275
Positive cash flow means you’re making money each month, while negative cash flow means you’re paying out of pocket. It’s important to analyze all expenses before purchasing a rental property.
Check out this blog on Cash Flow expectations for Indianapolis in 2025.
5. Net Operating Income (NOI)
Think of NOI as the money a property generates after covering operating expenses, but before mortgage payments. If you collect $2,000 in rent each month and spend $800 on maintenance, taxes, and other costs, your NOI is $1,200.
Example Calculation:
Total Rental Income: $25,000
Operating Expenses (Taxes, Maintenance, Management, etc.): $9,600
NOI: $15,400
A high NOI indicates a property is performing well, but financing costs and other factors should also be considered before purchasing.
6. Capitalization Rate (Cap Rate)
Cap rate is like a speedometer for your investment’s potential. It helps compare different rental properties by showing the return you’d get if you bought a property with cash. A 10% cap rate usually means a better return than a 5% cap rate—but also likely comes with more risk.
Cap Rate Formula: NOI ÷ Purchase Price
NOI: $12,200
Purchase Price: $200,000
Cap Rate: 6.1%
Cap rates vary by market and property type, and they should be used alongside other metrics for a full investment picture.
7. Cash-on-Cash Return
If you put $50,000 into an investment and it makes you $7,500 per year, your cash-on-cash return is 15%.
This helps you measure how efficiently your cash is working for you.
- Total Cash Invested (Down Payment + Closing Costs): $45,000
- Annual Pre-Tax Cash Flow: $6,600
- Cash-on-Cash Return: 14.67%
This metric is useful for investors comparing different properties or financing strategies.
Final Thoughts
Understanding these financial terms can help both beginner and experienced investors make smarter decisions.
Whether you’re evaluating a new rental property, refinancing an existing one, or planning your long-term investment strategy, these concepts form the foundation of a successful real estate portfolio.
Other Key Terms to Explore:
Debt-to-Income Ratio (DTI)
Gross Rent Multiplier (GRM)
Loan-to-Value Ratio (LTV)
Internal Rate of Return (IRR)
Vacancy Rate
