Investment terms explained
Seasoned investors often take their industry jargon to the next level. Feeling confused? Here are the most commonly abbreviated investment terms explained.
Blogger: Cam McLellan, CEO, OpenCorp
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Property investors often hear abbreviated industry terms and don’t know the difference between them. A classic example is ROI, ROE and IRR. Every industry has its own commonly used acronyms, shortcuts and phrases that can mean very different or very similar things. It is important to be familiar with these abbreviations so you can speak confidently and earn the respect of those in the field by sounding like you know what you’re doing.
A common abbreviation is PPOR: principal place of residence.
Another is IP, which can mean intellectual property in other contexts, but in the real estate world means investment property.
LVR and DSR are two big ones. LVR is loan to value ratio – the amount of your loan to the value of the property. DSR is debt service ratio, a calculation by the banks of how much debt you can service.
When measuring an investment, you might hear ROI, ROE or IRR: return on equity, return on investment and internal rate of return. ROI is the difference between the amount of coin I put into an investment and the return; so if I put in $100,000 and three years later I get $200,000 back on top of my initial capital… That is a good investment; I’ll do that again!
Return on investment and return on equity are similar, but IRR is very different. Internal rate of return is usually worked out on an annual basis – the annual return on your money compounding. The ROE over a two year period may be 40 per cent, but the IRR would be 20 per cent because it is calculated on an annual basis.
Terms that may seem similar can have different legal implications, like EP and JV. EP is equity partner and JV is joint venture.
ROC means return on cost, the return on the cost of something.
Everyone should talk to their broker and find out their BC, or borrowing capacity.
CE is cost estimate.
Another abbreviation I use a lot during projects is DD: due diligence. When we buy something, we exercise a lot of due diligence, dotting the i’s and crossing the t’s to make sure it is the right investment for us. When Al and I buy a project, we buy it subject to due diligence, so we can walk away from the deal at any time within 90 days of signing the contract.
PIA is property investment analysis. This should be done when purchasing an investment property to work out your net cash flow, including wage and tax brackets and costs such as ongoing maintenance and repairs. Depreciation and taxation should also be taken into account to give you the out of pocket amount.
LMI, or lenders mortgage insurance, is one that most property investors will know. The banks will typically lend up to 80 per cent, but if you want to borrow more – e.g. 90 or 95 per cent – they will bring in a lenders mortgage insurer to offset some risks and monitor the loan.
IDC is interest during construction and a QSR is a quantity surveyor’s report. A QSR is a tax depreciation schedule.
Another pretty basic one is CPI: consumer price index, a measurement of the change in the cost of goods over a time period.
LCR, or land content ratio, is a really important one. Land appreciates and buildings depreciate, so it is important to have the right land content ratio. At least half of your investment should be made up of the value of the land.
The next one is my favourite – OPM, or other people’s money. I love using OPM to get a higher ROI! There are two forms of OPM when you’re investing in property. You have the bank’s money, which is the gearing in your property. For example, you put in the initial 10 per cent and they lend 90 per cent. The other kind of OPM comes from your tenant, whose rent pays off the loan for you.
If you are an employee you have PAYG, or pay as you go taxation.
One that scares a lot of people is SMSF: self-managed super fund. They actually sounds much scarier than they are, and are worth investigating if you don’t have one already. If I’m with an industry super fund, there is probably some guy who has just finished uni sitting in a building somewhere with access to my super account, throwing darts to figure out where he should invest my super. If I take control of my own super fund, I take my account from him and take care of it directly. It is quite simple, but everyone needs to make the decision that is right for them.
Another big one is the PDS, or product disclosure statement. Product disclosure statements are approved by ASIC and provide an overview of any investment, the risks and fees associated and where the money will go. An IM, or information memorandum is similar to a PDS but not as detailed. They include a lot less of the regulatory information. Unsophisticated investors, who have earned less than $250,000 each year for the last two years or have less than $2,500,000 in assets, must be provided a PDS. These investors are not allowed to invest in projects that require only an IM. The rationale is that sophisticated investors have enough investment knowledge to make fast decisions, and it is not an ASIC requirement that they receive a PDS.
Development approval, DA, is relevant to development construction. If you want to put up 100 apartments, you need a DA to do it. The next step is getting building approval or BA. This means your building surveyors, and others who need to tick off elements of your plan, have given your construction the go ahead. This includes things like your engineering drawings and drainage approval. DA and BA can mean different things in different states, so be aware of your local terminology.
DMA is the development management agreement. If you have engaged someone to manage your development, this is the agreement you will have in place.
SPV is special purpose vehicle. I may choose to create an entity that operates as the vehicle for a specific development project, rather than using my other assets. There are tax and risk benefits involved in having singular special purpose vehicles for each project, rather than using one for all of them. This way any issues with one project don’t impact another project because they are totally separate entities.
EBT are earnings before tax.
An EOI or expression of interest is put forward when someone is considering lodging an application for your development. It is important to know the difference between NPV, net present value, and GRV, gross realisable value. GRV refers to the gross value of a finished project.
GA is gross assets, or the gross total of the amount of assets I have. Finally, NW is net wealth, or your real wealth, which comes from your GA.
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