Understanding a Business Requires a Strong Working Knowledge of the Language – Start With a Glossary
Much of understanding any topic is knowing the language. You can use years learning the terminology and definitions besides the many subtle requirements needed to perform in a business. Having a good glossary at your finger tips speeds the time of action dramatically.
Some good examples in real estate of vocabulary’s strength are terms like:
- Net Operating Income,
- Loan to Value,
- Debt Service Coverage,
- Capitalization Rate,
- Escrow Account, and
- Multifamily Housing
In residential housing real estate, these are shared terms. They can however be very enlightening. For example did you know that Net Operating Income is income before taxes and interest? This happens to be the same term as Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). EBITDA is a very shared term in many other businesses. Also, in some businesses Net Operating Income (NOI) is known as operating income. As you can see. Knowing this one very simple turn pulls back the curtain on much of what is calculated in the industry.
Another interesting term above is the capitalization rate. Capitalization rate is a term to describe value as a multiple of the Net Operating Income. Capitalization Rate is the ratio of net operating income to the total value. As an example, a capitalization rate of 10% implies a value of 10X NOI or Net Operating Income.
Wise investors will see to it that they have access to a good glossary of terms. And, they will work hard to ensure that they learn the complete terminology that defines their industry. Taking this step ensures that you understand the specifics of the deals you are participating in. You are avoiding misunderstandings and misunderstanding could cause you as an investor very large amounts of cash. however, understanding the terminology can show opportunities to you. For example, you receive a survey that describes multiple paths for a single project you are buying. You are able to determine that you can make your loan with the bank for the plots that are carrying cash producing assets only. After completing the deal, you are able to sell a number of unoccupied lots and generate many thousands of dollars of unburdened cash for your business. This is a real example that I myself witnesses and managed as part of a deal I was working on. What if I hadn’t understood the terminology and had missed the opportunity? meaningful loss to the company could have occurred.