We’re going back to the basics today, Anthony’s got a lesson for ya! Now, while some of you listeners may know these terms, it’s important to go back and review them. These are terms that EVERY real estate investor must know.
Don’t forget to check out this bonus episode on Youtube if you want to see Anthony face to face as he breaks down the essentials to real estate investing.
So… what are the top 5 terms?
Find out, in another bonus episode of Multifamily Investing Made Simple!
“These five terms are some of the most frequently used words you’re going to need to know in your lexicon” – Anthony Vicino
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top 5 terms
[00:00:00] Dan: Hey, what’s up guys. Anthony Pacino here of Invictus capital best-selling author of passive investing. Made simple here to tell you about the five terms that you must know as a real estate investor, whether you want to be passive or you want to be an active investor. If you want to be successful, you got to know how to speak the language.
And these five terms are some of the most frequently used words you’re going to need to know in your lexicon. All right, first up is cash on cash return. And this is probably the most common return metric that you’re going to experience when it comes to investing in real estate. Simply put it’s the annualized returns that you receive relative to the initial amount that you invested.
So if you put a hundred thousand dollars into a deal and you got $10,000, In that one year, then you have a 10% cash on cash [00:01:00] return. So we just, we get this by dividing the return by the total amount initially invested that gives us our cash on cash percentage. And this is a really important number because it just as simple as.
All the different ways that we could calculate a return and just says, Hey, for every dollar I’m putting into a deal, how much am I getting back? How much is that $1 working for me? This is a very good way to compare apples, to apples, different deals that might not look very similar because you just want to know, like, if I’m putting my money into this crypto over here or into real estate over here or into this fund on stock market over here.
How much am I getting cash on cash? It’s a great metric. All right. Number two. On the list of terms that you, as a real estate investor got to know is the I R R or internal rate of return. This is the gold standard of return metrics. When it comes to real estate syndications in particular, simply put it is the total time adjusted return of your investment.
Okay. So what’s, that actually mean? The reason the IRR is the gold standard of return metrics is because it’s the only one. [00:02:00] That takes into consideration, not just how much money you received in an investment, but when you received it, because as we know, like one of the principles of investment is, uh, the time value of money, a dollar in hand today is worth more than a dollar in hand.
For a whole lot of reasons, you know, one is the depreciation of the currency. As more currency is printed. Specially what we’ve seen in the last couple of years is 40% of all dollars in circulation were produced in the last couple of years. Well, when there’s more of something, the value of that thing decreases, which leads to inflation, right?
A dollar today in principle is worth less than a dollar down the road. So we need to take that into account when calculating the total value of our investment. So when you’re comparing, let’s say two different types of deals, the IRR is a really helpful way to figure out. Alright, how do I actually compare these things?
I’m comparing an apple to an orange. How can I create. Uh, a scale a system by which I can try [00:03:00] to compare these things equally on the same term. And one of these deals might be, say a value-add multi-family deal that we do where we’re looking for assets that cashflow from day one. So we’re getting cashflow distributions or, um, you know, on an annualized basis.
Might be say 10% cash on cash. So if we put in a hundred thousand dollars into a deal, maybe every year we’re getting $10,000 of cashflow. And maybe in year three, we do a refinance, which when we do that, we try to aim to return about 50% of our initial equity. So let’s say again, we put a hundred thousand dollars, then that means in years, two or three, when we do a refinance, we’re getting $50,000 back in addition to all the cash flows.
And then when we go to sell the asset, let’s say in your. You know, we get rid of the, um, the asset. We make a good profit. Let’s say we doubled our money. So as you can see in this type of a deal, we’re getting cash all throughout in different forms. We’re getting cashflow, we’re getting the proceeds from a refinance and we’re getting the proceeds from a sale, which is fundamentally different than let’s say a development deal where we’re going to go and we’re going to.
A skyscraper from the [00:04:00] ground up. There’s not going to be any cashflow because day one, we got to go dig a hole, day two. We got to go start filling that hole with concrete and all this stuff, right? So it’s going to be a pretty long road. And so we get to the point where this asset is going to be stabilized in generating cashflow.
It might be 2, 3, 4, 5 years, depending on how large the project is right now, typically with big development deals, what ends up happening is, and you do all this work and then you sell the asset, say in year five, just like. Uh, value multi-family deal. But now the amount that you’re getting is so much larger because you weren’t getting cashflow and distributions and all these things along the way.
Now it just comes as one big pop at the end. So which asset is more valuable and from a return perspective, is it the investment, a where are you getting cash flows all throughout the deal or is it CA a deal number two, where you’re getting it all at the end? Well, that’s what the IRR tells you on one deal.
It might be 17% on the other one. It might only be. Without that calculation, you wouldn’t really be able to look at those cashflows and say, which is more valuable than the other, which [00:05:00] is why the internal rate of return is the gold standard. When it comes to real estate return metrics that you got to know.
All right. Number three, on the terms that all real estate investors, they gotta know. You got to know this one is the concept of appreciation. Now appreciation is just simply put like the asset gets more valuable over time. It’s appreciating rather than depreciating. And when it comes to real estate, investing depreciation is a different concept entirely, but when it comes to appreciation, that just means our building is getting more valuable over time, which is a good thing right now.
When, when we think about appreciation, there’s two different types that you gotta be aware of. One is what we call organic appreciation, which is fundamentally different than forced appreciation. Here’s an example. Organic appreciation is when the market that you’re in the neighborhood, the city for whatever reason is going through a boom and everybody is doing really, really well.
The property values across the board are all going up and your asset [00:06:00] just by being in that area, as a consequence goes up. You don’t necessarily do anything to improve your building. You don’t run it more efficiently. You don’t make it better or anything. You’re just caught up in the wave of organic appreciation, which is not bad, like, especially in the last 10 years, most major markets in the U S have been organically appreciating fairly substantially.
So it’s been pretty easy just to make money by buying a building, doing nothing with it, and just riding that wave of organic appreciation and then selling it for a pretty little penny on the opposite. Is forced appreciation. This is when we go into a building and we make it better. We make it more valuable.
We do that by increasing revenues and decreasing expenses. And when we do that, the ultimate value of our building goes up because we’re running it more profitably. Now both of these things are really good, but we prefer forced appreciation because it gives us a lot of control. At the end of the day, organic appreciation is going to happen, or it’s not going to happen regardless of what you try to do.
It’s just outside of your control. [00:07:00] Forced depreciation on the other hand is entirely within your control as an operator. If you’re skilled, if you, if you level up your abilities, you can go in to these assets and make them vastly more valuable, which is why when we go and acquire buildings, we’re looking for opportunities to force appreciation, right?
The next term that you got to know as a real estate investor is equity. Now when you’re investing into a deal, it’s good to know without having to do advanced calculus, how much money do I really stand to make over the life of this hold? Like at the end of the day, that’s why we invest in things, right?
We want to see our money growing, but I don’t want to have to do advanced calculus to figure out how much do I really stand to make here? How much am I profiting? That’s where the equity multiple comes in. It’s a simple way of calc. How much did I put in and how much am I getting out all told on this project, for instance, on most indications that we do, we’re targeting at least a two X equity, multiple.
If you put in a hundred thousand dollars, then a two X equity, multiple is going to two [00:08:00] X. That which means all told by the end of the deal, you’re going to get around $200,000 back. A hundred thousand of that replaces your initial investment. A hundred thousand of that is profit. So when you’re looking at deals, equity, multiple can be skewed quite a bit by the length of the hold.
If we only hold the building for five years and it’s a two X multiple, that doesn’t necessarily mean it’s better than a deal where we hold it. Three years. And it’s only a 1.75 multiple, right? You got to calculate it for yourself based off of how long you’re holding it and got to use a little bit of context because equity had multiple on its own without knowing the length of the hold completely meaningless, but it is a nice back of the napkin way of calculating.
How much do I actually stand to make on this deal at the end of the day? How many dollars am I putting in. And last but not least on the terms that you got to know as a real estate investor is the concept of the preferred return. This is especially important for passive investors looking to invest in real estate syndications.
The preferred return simply put is a way of prioritizing limited [00:09:00] partners before general partners. It’s your claim on profits before the other parties in the deal we get to late their claim to the. So here’s an example. Let’s say we have a real estate syndication where the GPS are going to take 25% of the equity.
And the limited partners are going to take 75. This would be known as a 75, 25 split 75 go into the LPs 25 to the GPS, which means for every dollar of profit coming in, we would split it. 75 cents of that goes to the limited partners. 25 cents goes to the general partners, pretty simple, but. If the deal is structured in an advantageous way for the limited partners, there would be a preferred return in there, which simply says that the preferred that the limited partners need to generate a certain return before the general partners are allowed to start sharing in the profits.
This is important because without the preferred return, the general partners could just be profiting from a deal that’s going really, really poorly at the expense of the limited partners. So this is [00:10:00] not a guaranteed return, but it’s saying. Until the limited partners achieve X return, the general partners don’t get anything.
For example, most of the deals that we do at Invictus capital have about a 7% preferred. That is the minimum amount of return that our limited partners have to receive before we, as the general partners get to share in our side of the promote or that 75, 25 split. So again, if that $1 of profits coming in and we haven’t actually delivered a 7% preferred return to our limited partners, it’s not split 75 20.
It goes a hundred percent to the limited partners until that minimum 7% return is achieved. Once it is every dollar above and beyond that is split 75, 25. It’s a very important concept that signals that there’s good alignment of interest between the limited partners and the general partners. So always be on the lookout for it before you invest in an apartment.
So those are the five terms that [00:11:00] all real estate investors must know. You’ve got to cash on cash return. You got your internal rate of return, appreciation equity, multiple, and the preferred return. If you liked the video, if you got any value out of it, do us a favor, subscribe, hit the light button and leave a comment below about which one of these five terms you liked the most.