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Real Estate Investment Basics

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Due Diligence

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Due diligence in real estate is the process of reviewing all of the details of a property and the transaction surrounding it before the sale is finalized. This includes an assessment of the property’s condition, checking for liens, and analyzing financials.

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Amortization

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Amortization is the process of spreading out a loan into a series of fixed payments over time. The payments go toward both principal and interest.

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Cap Rate

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Cap rate, or capitalization rate, is a measure used to compare different real estate investments. It's calculated as the ratio of Net Operating Income (NOI) to property asset value.

Cap Rate=NOICurrent Market ValueCap\ Rate = \frac{NOI}{Current\ Market\ Value}

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NOI (Net Operating Income)

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Net Operating Income (NOI) is a calculation used to analyze the profitability of real estate investments. It is the total income the property generates minus all reasonably necessary operating expenses.

NOI=Gross Rental IncomeOperating ExpensesNOI = Gross\ Rental\ Income - Operating\ Expenses

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Escrow

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Escrow refers to a financial arrangement where a third party holds and regulates payment of the funds required for two parties in a given transaction. It helps make transactions more secure by keeping the payment in a secure escrow account which is only released when all of the terms of an agreement are met.

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Liquidity

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Liquidity refers to how easily an asset can be converted into cash without affecting its market price. Real estate is generally considered a non-liquid asset because it can take a significant amount of time to sell.

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ROI (Return on Investment)

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ROI measures the amount of return on an investment relative to the investment's cost. It is calculated by dividing the net profit of the investment by the initial cost.

ROI=Net ProfitCost of InvestmentROI = \frac{Net\ Profit}{Cost\ of\ Investment}

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Vacancy Rate

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The vacancy rate is a numerical value calculated as the percentage of all available units in a rental property that are vacant or unoccupied at a particular time.

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Equity

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Equity is the difference between the current market value of a property and the amount owed on its mortgage. It represents an owner's financial interest in the property.

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Loan-to-Value Ratio (LTV)

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The Loan-to-Value ratio is a financial term used by lenders to express the ratio of a loan to the value of an asset purchased. It is calculated by dividing the amount borrowed by the appraised value of the property.

LTV=Amount BorrowedAppraised Property ValueLTV = \frac{Amount\ Borrowed}{Appraised\ Property\ Value}

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REIT (Real Estate Investment Trust)

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A REIT is a company that owns, operates, or finances income-producing real estate. Investors can buy shares of REITs, providing a way to invest in real estate without owning the physical property.

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1031 Exchange

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A 1031 exchange is a swap of one investment property for another that allows capital gains taxes to be deferred. Specific rules must be followed, including the identification of the replacement property within 45 days and completion of the exchange within 180 days.

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Cash Flow

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Cash flow is the net amount of cash being transferred into and out of a property after all expenses are paid. Positive cash flow indicates that a property is generating more income than it costs to maintain and operate.

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Leverage

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Leverage in real estate is the use of various financial instruments or borrowed capital to increase the potential return of an investment.

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Depreciation

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Depreciation is the process of deducting the cost of buying and improving a rental property. For residential property, this is typically over a 27.5 year period; for commercial, it's 39 years. It allows investors to generate a paper expense that can offset rental income.

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