Today’s question is: How to calculate Return On Investment(ROI) in Real Estate?
How do you calculate Return On Investment in Real Estate?
Thinking about becoming a real estate investor? Wonderful! So, where do you start?
Location is key in investing. That’s a very important aspect as you want to make sure your home appeals to a wide range of potential future buyers/renters etc.
Another important thing to consider is whether you are looking for short term on long term investment?
Are you looking to get into house flipping, “wholesaling”, rental properties or maybe Airbnb?
How much money do you want to invest? Do you have cash or the investor needed down payment?
Let’s suppose that you have some money and you decide to buy a one unit condo, townhouse or detached residential property.
Now let’s calculate your Return On Investment(ROI)
ROI is calculated by using the following formula:
ROI = (Gain On Investment – Cost Of Investment) divided by Cost Of Investment
Please keep in mind that there are a number of variables that can come into play in Real Estate that can affect your ROI! These include maintenance expenses, repairs, interest on the money you borrowed to make the initial investment etc.
Let me show you an example:
Your purchase price is $225,000 and, you took out a mortgage.
- 30-year loan with a fixed interest rate 4.375%
- The down payment needed for the mortgage was 25% of the purchase price or $56,250 ($225,000 sales price x 25%).
- Closing costs and pre-paids totaling approximately $5,000 up front.
- You paid $0 for remodeling(best case scenario).
- Your total out-of-pocket expenses were $61,250 ($56,250 + $5,000).
- On the borrowed $168,750 ($225,000 sales price minus the $56,250 down payment), the monthly principal and interest payment would be Approximately $842.55/month
- Totaling: $1,284 per month including Taxes, HOA and Insurance
- To be safe, add another $150/month towards utilities = $1,434/month
- Rental income of $1,450 per month totals $17,400 for the year.
- Your monthly cash flow was of $1,450 – $1,434 = $16/month
- One year later:
- You earned $17,400 in total rental income for the year at $1,450 per month.
- Your annual return was $192 ($16 x 12 months).
To calculate the property’s ROI:
- Divide the annual return by your original out-of-pocket expenses (the down payment of $56,250, plus $5,000) to determine the ROI.
- ROI: $192 ÷ $61,250 = 0.00313
- Your ROI is 0.31%.
Do you think this is a great investment? Well, even if you add a steady 4% appreciation per year, it is probably not the best investment you can make.
So, now that you know how to calculate return on investment, choose your investment property wisely! Talk to a knowledgeable realtor who is familiar with the area and knows how to find a great deal.
If you have any questions on how to calculate return on investment or, just general real estate, please feel free to reach out to us any time! We are here to help!
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If you need help on how to calculate return on investment, please feel free to reach out to me any time via email, text, chat or using the form on the page!