Practice Note: Understanding Affordable Housing Investments Better – Key Investment Terms Explained

The Open Access Initiative (OAI) aims to address information asymmetries in Africa’s affordable housing market by harnessing the collective experiences and learnings produced by investors and developers through their investments in affordable housing.  This practice note shares the definitions of investment terms and concepts and jargon to better understand the investment space:

1. Capitalization Rate (Cap Rate): The Cap Rate is the ratio of a property’s net operating income in a year (i.e. the money earned from rent less all operating expenses) to its purchase price. It estimates the potential return on investment.
2. Gross Construction Cost per Square Meter: This metric represents the cost to build one square meter of a property, including materials, labour, and other expenses. It is calculated by adding up the total gross built up area and dividing by the total square meters of the property, including common areas. Understanding this cost is crucial for estimating the overall investment required for an affordable housing project.
3. Debt Service Coverage Ratio (DSCR): DSCR measures a property’s ability to generate enough income to cover its debt payments. It is calculated by dividing the net operating income by the total debt service in one year (i.e. the amount paid back to the lender for the outstanding loan). A DSCR greater than 1 indicates that the property generates sufficient income to cover its debt obligations.
4. Equity Multiple: The equity multiple measures the total return on an investment relative to the amount of equity invested. It is calculated by dividing the total cash distributions by the total equity invested.
5. Gross Built-Up Area (GBA): GBA is the total floor area of a building, including all covered spaces such as lobbies, stairwells, and utility rooms. This measurement is essential for calculating the overall size and value of a property.
6. Gross Lettable Area (GLA): GLA refers to the total area within a building that can be rented out to tenants, excluding common areas like hallways and restrooms. It focuses on spaces that generate rental income.
7. Gross Rental: Gross rental income is the total income a property generates from rent before any expenses are deducted. It provides an initial measure of a property’s earning potential.
8. Gross Rental Yield: Gross Rental Yield is the annual rental income generated by a property, expressed as a percentage of its total cost or value, and excluding operating costs, taxes and finance. It is calculated by dividing the annual rental income by the property’s purchase price and multiplying by 100.
9. Internal Rate of Return (IRR): IRR is a metric used to evaluate the profitability of an investment over time. It represents the annualized rate of return that makes the net present value of all cash flows (both incoming and outgoing) equal to zero. It helps investors compare the profitability of different investment opportunities.
10. Loan-to-Value Ratio (LTV): LTV is the ratio of a loan amount to the appraised value of the property. It is used by lenders to assess the risk of a loan. A higher LTV indicates higher risk of loss given default, as it means the borrower has less equity in the property and the loan amount is closer to the property’s value.
11. Net Operating Income (NOI): NOI is the total income generated by a property after operating expenses are deducted but before taxes and financing costs. It is a critical measure of a property’s profitability. NOI formula adds the rental income and ancillary income of a property, and then subtracts direct operating expenses.
12. Net Present Value (NPV): This is a financial metric used to evaluate the profitability of a real estate investment. It represents the difference between the present value of cash inflows (such as rental income, tax savings, and future sale proceeds) and the present value of cash outflows (such as the purchase price, maintenance costs, and property management fees) over a specified period of time.
13. Net Rental: Net rental income is the gross rental income minus expenses such as maintenance and management fees. It represents the actual profit an investor can expect to receive.
14. Net Rental Yield: Net Rental Yield is similar to gross rental yield but takes into account expenses such as maintenance, property management fees, finance costs, and taxes. It provides a more accurate picture of the actual income generated by a property. It is computed by dividing the total rent less expenses divided by the total market value of the property.
15. Return on Investment (ROI): ROI measures the gain or loss generated by an investment relative to its cost. It is expressed as a percentage and helps investors assess the efficiency of their investment.
16. Vacancy Rate: The vacancy rate is the percentage of all available rental units that are vacant or unoccupied at a given time. It is a key indicator of market health and demand for rental properties.

By familiarizing yourself with these key terms, you can better understand and navigate the world of affordable housing investment. Whether you’re a seasoned investor or a newcomer to the field, these concepts will help you make more informed decisions and maximize your returns while contributing to the community. If we have missed  out on any terms, please drop them in the below comment box for us to define them.