Calculating return on investment (ROI) is an important part of any successful business. In real estate, it provides valuable metrics about a property and whether it’s worth your time. When you learn how to accurately measure ROI, you can make smarter real estate investment decisions and become better at selecting properties.
Whether you plan to use a long-term investment method like buy and hold real estate or a short-term method like flipping homes, calculating ROI will help you in every aspect of investing in the real estate market. Specifically, you can use ROI to:
- Buy an investment at the right purchase price.
- Sell an investment at the right sale price.
- Set a favorable rent price to produce enough rental income.
- Modify rental operating costs to improve potential returns.
- Estimate annual cash flow.
- Set a budget for annual repair costs.
- Calculate potential returns before buying.
When real estate investors want to make informed decisions, calculating a property’s rate of return can give valuable insights. Every property investment operation should use ROI formulas frequently, figuring numbers like net operating income, expenses, and other risk factors like occupancy rates to determine how much you can make from a property.
How Can I Calculate ROI?
ROI is the difference between what you invest and what you earn from your investment. It’s usually presented as a percentage. There are variety of formulas and calculators you can use to get these figures. For simplicity, you need to know at least four basic formulas for ROI calculation in real estate:
- Net operating income (NOI): Total real estate revenue – total operating expenses. Mortgage payments, taxes, interest, depreciation, capital expenditures, and amortization are not calculated into NOI.
- Cash flow = Total rental Income – Total rental expenses. This includes income taxes, mortgage payments, depreciation, and amortization.
- Cap rate = NOI / cost of the investment (according to current market value). This formula does not figure in mortgage loan payments. It’s a go-to metric for all-cash buyers to use for fast estimations.
- Cash on cash return = Yearly cash flow/Total Cash Invested. This formula figures in mortgage loan payments and is ideal for investors that use loans to buy properties.
ROI is ideal for determining immediate profit and is less accurate when trying to estimate long-term profit. By using these formulas, you can get different insights and determine whether an investment meets your needs. It’s best to use as many formulas as possible to get multiple perspectives on your situation.
What is a Good ROI?
When calculating your return on investment, using more than one relevant formula will help get the most accurate assessment of your potential investment. While the first formula provided about cash flow gives you a unique number that is proportionate to your earnings minus expenses, the cap rate and cash on cash return formulae offer a percentage to show you how much yo.
- Ideal cap rate: Opinions differ, but the majority of sources report an ideal cap rate is between 8% and 12%, but other sources say as low as 4% is fine, though it’s on the side of risky.
- Ideal CoC return: Investors generally agree that a cash-on-cash rate between 7% – 10% is healthy, while others prefer a rate of at least 15%.
There are exceptions to every “rule,” and that you can still measure success in other ways. Your investment goals are unique, and therefore you can determine whether your investment property is viable based on your personal standards. However, these guidelines exist for a reason as many experienced investors came up with these numbers that helped boost success.
Figure ROI Into Your Investment Plan
By understanding how to calculate return on investment in real estate, you can make smarter decisions that will serve you both now and in the future. When you do a little homework in rental property investing, you can make the best business decisions.
If you need help finding the ideal types of properties for investing, Marketplace Homes can help you fine-tune your real estate search. Don’t forget to link up with a financial advisor to get the most accurate ROI calculations!