When you start investing in real estate, some terminology is necessary. Developing a professional vocabulary builds a solid foundation for your career and gives you a “head start.”
Don’t stop learning. This information is just a beginning. If you are an intermediate, or expert, vow to keep learning.
Even those already in the business can learn from others. I do.
I started investing in 1988. I knew very little about the real estate industry at large. For my first exposure to investing, I went to the library and got as many books as I could on real estate. And I remember reading them and all I read made very little sense to me. I didn’t even understand the terminology.
When they said “a second note,” I didn’t understand what a second was. So…I am going to cover some terminology.
I am going to go on the assumption that the reader doesn’t have a real estate background.
So I am going to try to start from the beginning – I’m not going to go into complete detail on the number of ways to invest. They are too numerous to cover here – and there are way more than I know.
My focus is going to be primarily on fixer uppers, wholesale buying, lease options, and pre foreclosures.
There is so much more to real estate investing than I knew when I first started. At first I thought of real estate investing as – you know – find a broken down house, fix it up, and sell it.
Which is good – that is one way to earn money, in fact it can be very lucrative. But there is so much more – much more that I was missing out on. There are other basics, like options, wholesale (also called quick flips), and pre foreclosures.
I can remember one of my earlier deals. It was a very good deal – it was a house – actually, it was two duplexes- 4 units total. It was an estate sale. The children basically wanted to get rid of the property – they didn’t want tenants. It was owned free and clear.
They wanted, I think, a hundred and twenty thousand dollars for the property, which was an absolute steal. You know – four units. If I recall right it was renting below market at $450 and was worth at the time $600 per unit. The rental rate today would be about $900 or so.
So this was a very good deal. I actually offered them $105,000 and inserted all sorts of requests, like asking for a new roof. And it didn’t need any repairs at all – it’s just that I was new and the thought of putting on a new roof kind of scared me. So I kind of threw it in there just because I didn’t know what I should do.
I was surprised when they accepted my offer! Additionally, it also had a lot next to it which could accommodate 4 more units.
So, the deal was very good – but I had no money. No money whatsoever. I even had to borrow $1000 from my mother to put down as earnest money.
What eventually happened on this deal was, I wasn’t able to close.
I was very young and didn’t have a great job as a government employee. I didn’t have a lot of income, so the banks really didn’t want to even look at me.
I think the banks wanted me to put down something like twenty percent. Which, of course, I didn’t have.
And I didn’t have bad credit. It’s just that I didn’t have much credit at all. Maybe a Sears card and that was about it.
So no bank would loan to me. And that was my initial problem. Borrowing from a bank was the only way I knew to get a loan.
I learned later that there are many other ways to pay for a real estate purchase. I was unable to fulfill my offer on this first deal, but I didn’t lose my Mother’s thousand dollars. I got that back. If I knew what I know today, I would have been able to close that deal.
I knew nothing at the time about partnering. I didn’t know I could bring in a partner to put up the down payment or float the loan.
On this particular deal, I probably could have gotten a hard money loan since the value was already there. Usually on hard money loans is about 60 to 65% loan to value.
And what that means is, if a person wants a hundred thousand dollars on a purchase, the hard money sources are willing to lend sixty thousand or sixty-five thousand dollars.
So I didn’t get this particular deal. There were numerous things I could have done in retrospect. So losing that first deal made me aware that I needed more education.
Education starts with learning some basic terminology.
I am going to review several terms essential for understanding the real estate investing profession. My definitions are not legal definitions nor are they complete definitions, but just my own understanding of them. I am going to start with Assignment.
Assignment means conveying the rights you have in a contract to someone else. Transfer is made to some other person by way of a document. So if you want to convey a contract to someone, an assignment allows someone else to step in as you.
You might use an assignment to convey a house purchase to someone else. An assignment can be handy when you want to put a house under contract and then flip your deal to someone else instead of doing the rehab work yourself. An assignment is also called wholesaling.
Balloon payment is a large final payment due on a loan. For example, you might have a loan amortized over thirty years, but the purchase agreement requires that you you cash out in five years. This is referred to as a five-year balloon.
Earnest money is a deposit of money to bind a purchase. It is usually given to a real estate agent or escrow company directly. Never give money directly to a seller.
If the seller has no agent, you can give the money to the escrow company or lawyer who will be closing the transaction.
Equity of Real Estate is the value of interest a person has in a property. For instance, a house worth one hundred thousand dollar houses without a mortgage (or, free and clear) has an equity of $100,000. If an underlying mortgage was on the same house, the equity would be twenty thousand dollars.
An Escape Clause in a purchase contract is an exit right for you in the purchase. For example, you can (and should) write in one or more escape clauses in your contracts. It might read, “subject to financing,” which means you do not have to fulfill the contract if you cannot obtain financing on the purchase. You can use any sort of escape clause you choose, such as “subject to my partner’s approval” or “subject to inspection.” This clause allows you to exit the contract.
Flipping is a terminology used for turning over a house quickly. You’ll hear it referred to as “quick flipping”. You’ll also hear it called “wholesaling,” although wholesaling is a specific type of flipping.
First deed of Trust is a deed, recorded first, terminology used in some states. For example, if you purchased a house for $100,000 by taking out an $80,000 loan with the house as collateral, and the seller agreed that you would owe him or her twenty thousand dollars for the balance, then the first recorded loan amount owed would be called the first deed of trust [in a deed of trust state] and the second recorded loan would be called the second deed of trust. So the amount you owe to the seller is called the second – or the second note. And the eighty thousand dollar amount owed is called the first note.
Hard money loans where you don’t use a bank are companies or individuals who use the property as the collateral. These loans usually don’t go over 65% loan to value. They tend to not have as much red tape as banks, so you can usually close quicker than with a bank. The draw back to hard money is that interest rates are higher than bank rates.
If you were getting a hard money loan on this hundred thousand dollar house, the hard money loan source would not loan you more than sixty-five thousand dollars max.
You can usually find these hard money sources in the newspaper, or by word of mouth. Or sometimes by attending the real estate investment club in your vicinity.
The best hard money sources to find are individuals you encounter on a personal basis during your career in real estate investing. They are often someone with money sitting idle in a bank. You might find them among neighbors, family, and friends – associates who have confidence in you who want a greater return on their idle money and who want the security of a collateralized loan.
Junior lien is just a terminology for a lien that holds second position to the first mortgage. isn’t in first place on a house. The second mortgage in our earlier example of a $100,000 house with a $20,000 second loan is referred to as a junior lien because it is not in first place. Sometimes it is called a subordinate lien.
Lease option is the right to rent a house for a period of time, and then hold an option to purchase the house. The renter does not have the obligation to buy the house, but only the right to buy at a set price by a set time. All of the particulars of the lease option are contained in a legal document.
An Option is a right (usually a paid right) to purchase a property, but without any reference to renting. If you found a house to buy but did not want to rent it out to anyone, you might ask the seller for an option to buy. This kind of transaction might be desirable when your delay in buying for any reason (such as finding partners, raising funds, etc.) might lose the purchase to someone else if you do not place it under option.
Sometimes you find a property which can be placed on an option for the simple purpose of finding another buyer who will pay you for your option or will pay a higher price for the property than your optioned price.
As with all of your variations in purchasing property, check with a knowledgeable attorney who specializes in real estate.