Real estate investing involves purchasing, ownership, management, renting, and sale of real estate properties for a profit. Investing in real estate is like building up equity in assets with limited liquidity relative to other investments. Besides, it is also capital intensive. It means that though money may be gained through mortgage leverage, the cash flow remains highly dependent.
Calculating ROI
For calculating the profit or gains on any investment, simply subtract your investment capital from the revenues you’ve earned. Now, you need to find the ratio of gains or profits. Since it is a profitability ratio, it is represented in percentage. According to a spokesperson at a DC property management company, the percentage ROI is calculated by taking the net gain or the net profit on the investment and then dividing it by the original cost. For example, if you have a stock bought for $1,000 and you wish to sell it after two years at $1,600, your net profit will stand to be $600. The calculated ROI on the stock would be 60% as $600 (net profit) / $1,000 (cost) = 0.60.
Calculating ROI on Rental Properties
Depending upon how you purchase your rental property, the ROI calculations would vary. Keep reading to know more.
ROI for Cash Transactions
Here is an example of a rental property purchased with cash. Let’s assume that you pay $100,000 in cash, and the closing costs are $1,000. After remodeling costs of $9,000, your total investment becomes $110,000 for the property. If you collect $1,000 in rent every month, in 12 months, you can easily earn about $12,000 in rental income. After deducting various expenses like water bills, property taxes, insurance, the total can be $2,400 yearly or $200 monthly. After paying the entire sum from the total rent, your annual return would be $9,600 ($12,000-$2,400). To calculate the ROI, all you have to do is divide the annual return by the amount of total investment, i.e., $9,600/$110,000. The sum you get, 0.087 or 8.7%, will be your ROI.
ROI for Financed Transactions
Assuming that you have bought the same property of $100,000, you take it on a mortgage instead of paying cash. The down payment needed is 20% of the purchase price, or $20,000. The closing costs are a bit higher and come out to be $2,500. After paying $9,000 for remodeling, your total out-of-pocket expenses stand to be $31,500 ($20,000 + $2,500 + $9,000). Taking a 30-year mortgage with a fixed 4% interest rate, on the borrowed $80,000, the monthly principal and interest payment would be $381.93. Adding another $200 to cover other expenses like water, taxes, insurance, etc., per month would make the total amount $581.93. Keeping the rental income $ 1000 per month would generate $12,000 for the whole year, leaving a monthly cash flow of $418.07 ($1,000 rent – $581.93 mortgage payment). After a year, your annual return would stand to be $5,016.84 ($418.07 x 12 months).
Calculating the ROI will need to divide the annual returns by the actual out-of-pocket expenses, which will be $5,016.84 ÷ $31,500, which would equal 0.159 or 15.9%.
Last Word
Various variables come into play with real estate that can affect the ROI numbers. These can include maintenance and repair expenses, methods of figuring leverage, and the amount of money borrowed with interest to make the initial investment. Financing terms can significantly affect the overall cost of the investment.
