GLOSSARY

Purchase price
The purchase price of the property is the price that was paid for the property excluding closing, or conveyancing costs, stamp duty and other expenses.

Market value
Whereas the purchase price is the actual price paid, the market value of a property is what it is actually worth on the open market, usually determined by a valuer.

Conveyancing or closing costs
Closing costs are the fees charged by a solicitor or conveyancer, to transfer the ownership from the seller to the buyer. These costs can vary depending on the property cost and how much legal work is involved with the purchase of the property.

Initial cash investment
This is the amount of cash the investor puts into the property at the time of purchase. It represents the entire cash contribution to cover the purchase, the loan application fees, closing costs and any other expenses. The purchase price plus all costs less the cash investment must therefore equal the mortgage.

Rent
This includes the rent for the property on a weekly, monthly or annual basis. The vacancy rate is expressed as the percentage of time that the property is not occupied.

Management fees
The management fees may be expressed as a fixed amount per year, or a percentage of the rent collected. These are the fees charged by a letting agent to find new tenants, collect the rent, maintain the real estate and send you your net rental income.

Loan amount
This is the remaining amount of money required to cover the total cost of the property (including closing costs and mortgage application fees) over and above the initial cash investment.

Loan term
This is the number of years it will take to pay off the entire loan including the interest.

Loan type
Interest Only or Principal and Interest. Interest Only is where you pay interest, but no principal. At the end of the term you therefore have to repay the entire mortgage. Principal and Interest is where each payment comprises interest on the principal outstanding plus an extra amount for principal repayment. At the end of the term you have repaid the entire mortgage.

Loan cost
The cost of the loan is a combination of a number of expenses which may include an application fee and a valuation fee. More items may be added to the list.

Loan rate
The interest fixed for a number of years, or specified for each individual year.

Renovations
Any renovations made to the property are treated as capital improvements and are therefore added to the market value of the property. This contrasts with repairs and maintenance which are tax deductible expenses.

Expenses
Expenses comprise ongoing annual costs associated with the ownership of the property. Examples include insurance, maintenance, association fees and property taxes.

Fixtures and fittings
It is worthwhile compiling a list of all fixtures and fittings to ensure maximum benefit from depreciation.

Cash flow
The process of taking all of the cash inflows into a project, minus all of the outflows of that project, on a periodic basis, usually monthly. It does not contain notional amounts, such as depreciation.

Discounted cash flow (DCF)
The effect of reducing cash inflows and outflows by a given percentage to reflect the future fall in the value of cash. It requires forecasts of future inflation rates.

IRR
The internal rate of return looks at how the cash flows and property values change with time. To do this it takes what the projected growth rentals will be, what the capital growth is expected to be, what the mortgage interest payments will be given that the principal is slowly being paid off, and what depreciation can be claimed each year.

Then the appropriate rate of inflation is used to calculate the Net Present Value of the inflows and outflows, in any one year.

The internal rate of return is the return a bank would have to give you, such that if you gave the bank the initial cash investment in the prospective property, they would give you the annual net inflow from the property for each of the years over the period, and at the end of the period gave you your increased equity in the property.

IRR takes the time value of money into account. A pound now is worth more than a pound in say five years time.

The additional feature of IRR is that it is what is called ‘dimensionless’, i.e. it is just a number, expressed as a percentage. This means we can compare the IRR for say a two bedroom apartment in one location with say a three bed semi in another, a retail/commercial investment in a third, or with any other investment. This sophistication of analysis helps decision making by greatly reducing risk.

Yield
Be wary with this term. Estate Agents use ‘Yield’ to mean the potential rent for a property divided by the proposed purchase price for that property, expressed as a percentage. It is of limited interest to us, because it does not reflect the size of any loan used to purchase the property. It is not comparable with ‘Yield’ used in the context of shares in quoted companies on the Stock Exchange, where all of the capital used is normally provided by the investor.

(See Internal Rate of Return above)

Capital Employed
This consists of Total Assets less Current liabilities.

The Rate of Return on Capital Employed
This is a financial ratio of such importance that it deserves special mention.
In any business activity, an increase in efficiency will result in an increase in profit. Therefore, any change in the Rate of Return of Capital Employed will reflect the efficiency with which that business is carried on. In general, the efficient use of capital, indicated by an increase in the Rate of Return, will promote GROWTH. Note that this ratio, Profit divided by Capital Employed and expressed as a percentage, can be increased by increasing profit, reducing the capital employed, or of course, doing both.
This is the essence of business; maximising the return on an activity, whilst minimising the capital used.

Leverage
Leverage is the use of mortgage financing to purchase an investment property with only a small cash deposit, with the expectation that depreciation and inflation will create a disproportionately high return on the original investment.

LTV
Shorthand for the loan used to buy a property expressed as a percentage of the purchase price, or valuation.