Property investment jargon and terminology
One of the things that makes any subject matter daunting and complex is a lack of knowledge and understanding. This is even more so when terms and jargon that are unfamiliar to us are used. The purpose of this publication is to bring clarity to a few terms used in the context of property investment. As such, here are some property investment jargon and terminology explained.
Let us start by examining capital gain. Capital gain can be viewed as the amount by which a piece of real estate appreciates in value relative to the amount for which it was purchased. Put another way, capital gain is the profit generated from selling real estate at a higher price than the purchase price. For example, if you purchased a property for K350,000 in 2005, and that particular property is now worth K1,000,000, then your capital gain is K650,000.
Capital gains tax
Secondly, we will examine capital gains tax. Capital gains tax is a form of tax paid on an asset that has made a capital gain. With regards to real estate and property investment, capital gains tax is a tax you pay on any capital after selling a property.
When it comes to property investment, cashflow positive if your income is greater than your outgoings. Remember to keep tax deductions in mind and take them into account when doing your calculations. In a nutshell, tax deductions include depreciation, interest paid on your mortgage loan, and service costs.
The concept of equity is quite confusing for a lot of people. However, it need not be confusing nor complex to grasp. To put it in laymen’s terms, equity is your stake or ownership in something. In property investment, equity is how much of a property you own. Let us look at equity in a different way; if you own a property worth K800,000 and you still owe K300,000 on your mortgage loan. Then your equity is K500,000 or 62.5 per cent. It is important to note that one of the biggest advantages of equity is that it can be used to leverage other loans and further property investments.
Loan to value ratio
The loan to value ratio is the proportion of the property portfolio that you own in relation to its overall value. Most lenders and financial institutions carefully scrutinise your loan o value to determine if you can afford a loan.
Mortgage insurance can also be referred to as lenders mortgage insurance. This is a type of insurance that a borrower might be required to purchase as a condition for securing a mortgage loan. In essence this type of insurance is designed to insure the lender from you defaulting. Remember that mortgage insurance does not provide any sort of cover for borrowers and it can also cost a great deal of money.
We already spoke about cashflow positive, but what happens when your outgoings are greater than your income? When outgoings plus tax deductions are greater than the income generated by the property there is negative gearing. Negative gearing means you are losing money on that property and that you have to make up the shortfall in some other way.
Some property investors tend to use the terms positive gearing and cashflow positive interchangeably. However, there is a very clear distinction between the two terms. To start with, a cash flow positive property returns a positive after tax deductions are factored in. On the other hand, a property that is positively geared generates more income than expenses regardless of tax deductions.
The rental yield of a property is expressed as a percentage. Rental yield denotes the return on investment as a percentage of the investment made on that property.
Serviceability refers to your own personal cash flow and other income. Your serviceability plus your loan to value ratio are crucial to determining your suitability for a mortgage loan.
The transfer of property incurs a government cost referred to as stamp duty. The stamp duty translates into a considerable amount and therefore requires serious and thorough consideration.