Real Estate Investing 101

Capital expenditure

Capital expenditure (also known as “capital expense,” “CAPEX,” or “capital cost”) is money that a company spends to acquire, maintain, or improve physical assets such as property, buildings, and equipment. These expenditures are typically long-term investments that are expected to generate future economic benefits for the company. 

Examples of capital expenditures include purchasing land, constructing a new building, buying machinery or equipment, and renovating or upgrading existing assets. In contrast to operating expenses, which are incurred in the day-to-day operations of a business and are typically short-term in nature, capital expenditures are typically made to support the long-term growth and development of a company.

Capitalization rate

Cap rate, or capitalization rate, is a measure of the ratio between the net operating income of a property and its value or purchase price. It is typically expressed as a percentage. The cap rate is used to estimate the potential return on an investment in a rental property, and is often used to compare different properties as a means of identifying which one may be a better investment opportunity.

To calculate the cap rate, you divide the property’s net operating income by its purchase price or value. For example, if a property has a net operating income of $50,000 per year and a purchase price of $500,000, the cap rate would be 10% ($50,000 / $500,000).

Cap rates can vary widely depending on a number of factors, such as the location and condition of the property, the state of the local real estate market, and the overall economic environment. In general, properties with higher cap rates are considered to be better investments, as they offer the potential for higher returns.

Cost segregation studies

Cost segregation studies are a tax planning strategy that can be used by commercial property owners to reallocate the costs of a building and its components between personal property and real property. The goal of the study is to identify assets that can be classified as personal property, which is depreciated over a shorter period of time than real property, in order to increase tax deductions and decrease tax liability.

The cost segregation study is performed by a qualified cost segregation expert, who will perform a physical inspection of the property, review blueprints and construction documents, and conduct interviews with the property owner and any relevant parties. The study will identify all of the assets within the building that qualify as personal property and estimate the cost of each asset. These costs are then segregated from the costs of the building and its other components, which are considered to be real property.

Examples of assets that may qualify as personal property include:

• Trade fixtures (shelving, display cases, etc.)
• Equipment (air conditioning units, boilers, etc.)
• Building systems (electrical, plumbing, etc.)
• Landscaping and site improvements (parking lots, sidewalks, etc.)

Once the study is complete, the property owner can use the information to reallocate costs and depreciate the personal property over a shorter period of time. This can result in significant tax savings, as the property owner will be able to take larger deductions in the early years of ownership.

It’s important to note that cost segregation studies can be complex, and it’s important to work with a qualified expert to ensure that the study is done correctly and complies with all relevant tax laws. Additionally, it’s important to be aware that cost segregation studies are subject to audit by the IRS, and it’s important to have detailed and accurate records to support any cost segregation calculations.

ROI

There are a few different ways to calculate the return on investment (ROI) for real estate, but the most common method is to use the capitalization rate, or cap rate. This is calculated by dividing the net operating income (NOI) of a property by the property’s current market value.

For example, let’s say you purchased a rental property for $200,000 and it generates $20,000 in net operating income per year. The cap rate for this property would be 10% (20,000 / 200,000).

Another way to calculate ROI is to use the total return approach, which takes into account not only the income generated by the property, but also any changes in the value of the property over time. To calculate total return, you would add the annual net income from the property (including any appreciation or depreciation in value) to the initial investment, and then divide that number by the initial investment.

For example, if you purchased the same $200,000 property and it generated $20,000 in net income per year, but also appreciated in value by 5% per year, your total return would be 15% (20,000 + (200,000 x 0.05)) / 200,000).

It’s important to note that these are just a couple of examples of how to calculate ROI for real estate, and there are many other factors that can affect the return you can expect to receive from a property. These can include the location of the property, the local real estate market, the condition of the property, and the level of demand for rental properties in the area.