The ultimate goal of investing in real estate is to earn a return on your money. Apart from that, one of the best things about commercial real estate investing is that it can provide you with a monthly dividend through cash flow while yielding appreciation over time.
The high return on investment (ROI) of commercial real estate may have repeatedly been emphasized to you as an aspiring or current real estate investor because it is more profitable and higher-yielding.
Even so, you may still wonder what exactly constitutes a good return on your commercial real estate investment.
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What is Return on Investment (ROI)?
When investing in commercial real estate, return on investment (ROI) measures the profit or money generated on a property investment as a percentage of its cost.
The ROI of commercial real estate is determined by subtracting all associated expenses, such as repairs, renovations, rehabilitation costs, and purchasing costs, from the invested capital.
An investor can determine the profitability factor of a commercial property quickly by looking at the ROI.
How Do You Calculate ROI for Commercial Real Estate?
As a starting point, every piece of real estate comes with multiple costs. A commercial real estate investment’s ROI is affected by many factors, including whether the property has any commercial real estate loans on it, the interest rate on those loans—as well as other costs including:
- Purchase price
- Principal and interest
- Capital improvements
- Common area maintenance (CAM).
- Property taxes
- Property management
Compared to other investments, commercial real estate requires a little more effort to calculate ROI.
To calculate your returns, you will need to decide whether to include any cash you borrow as a cost or if you only want to include out-of-pocket expenses.
Two commonly used methods for calculating ROI are described below, the cost method and the out-of-pocket method.
Cost Method for Calculating ROI
When determining ROI using the cost method, we divide the existing equity in a property by its purchase and ownership costs. Calculating on the basis of the cost method simplifies the calculation since it does not take into account any existing debt on the property.
Additionally, we do not include any income received during the rehab period if the property was partially rented.
Out-of-Pocket Method for Calculating ROI
The out-of-pocket method includes the debt on the property in the calculation as opposed to the cost method.
In order to simplify this process, the mortgage payments during the rehab period are not included, nor does any rental income if the property was partially rented during that time.
Other Methods for Evaluating ROI
Depending on their commercial real estate strategies, investors may also calculate the return on investment for a commercial property using other methods aside from the out-of-pocket and cost methods.
Additionally, cap rates, cash-on-cash returns, and gross rent multipliers help real estate investors understand ROI:
- Cap rate – net operating income (NOI) divided by a property’s market value
- Cash-on-cash return – annual dollar income divided by total dollars invested
- Gross rent multiplier – property price divided by gross rental income
What’s a Good ROI for Commercial Real Estate?
Investors will have different opinions about what constitutes a good ROI, as everyone has their own perspective. Higher returns can be expected if you take on more risk, though greater downturns are also possible in this scenario. In contrast, your expectations must be moderated if you follow a more conservative strategy.
On average, real estate investors generally expect their assets to appreciate at a rate similar to the S&P 500, which has historically generated 10% returns annually. Generally, an ideal cap rate is between 4% and 10% in relation to rental income.
Commercial Property Investments: How to Get the Best Returns
Depending on the variables considered and the overall risk-taking ability of investors, it is possible to calculate commercial real estate returns on investment in a simple or complex manner.
When determining what a good ROI on investments is, it is crucial to take all the contributing factors into account. Working with an expert who knows what to look for when investing in commercial real estate might be beneficial in making an informed purchase decision as an investor.
Work with Financial Professionals at Saint Investment Group!
Commercial real estate investment offers many risks, but getting a good investment return is possible. Furthermore, if you are looking to achieve impressive results, you should connect with professionals in the real estate industry that you can trust.
We would be glad to assist you in finding these kinds of real estate investment properties or calculating any costs associated with your property. Our team has experience in every aspect of real estate investment and management.
Consider us your partner in achieving your investment goals. For more information about how we can help you, contact us at 949-881-7128 at Saint Investment Group today!
President of Saint Investment Group
Nic is a two decade seasoned expert in investing and capital raising, specializing in Real Estate and debt markets. With Saint Investment Group, he leads large-scale distressed asset purchases and innovative syndications for investors.