When it comes to real estate investing, the vast majority of prospective investors will ask one question above all else—” What kind of return on investment can I expect?” Leading with this question may seem like a simplistic approach. However, the calculations involved in real estate return on investment stats cover a wide array of factors that indicate overall value.
It’s essential to have a strong understanding of the utility of calculating real estate return on investment before buying property. In this article, we’ll cover some of the key details about what’s included in ROI, what kind of ROI to expect in real estate, and how you can invest without having to run complicated calculations.
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A key performance indicator (KPI) is a metric that can be used to make quick pass/fail decisions in investing to save time when filtering deals. Return on investment (ROI) in real estate is the ultimate KPI for filtering which properties to invest in. Why is this?
The ROI metric factors in the core costs of a property along with potential repairs and updating costs that will affect the net profit on the deal. Therefore, ROI is one of the best ways to quickly gauge whether a property fits within your key performance criteria for investment. So, what sort of ROI figures can you expect when it comes to real estate investing?
Generally, investors use a baseline indicator for ROI to gauge investment performance. For most, this baseline indicator is the average ROI over time for the S&P 500, a stock market index of 500 companies. For the past 50 years or so, the ROI for the S&P 500 has hovered around the 8% mark, so this is often what some investors expect as a minimum ROI for investment properties.
Determine what your long-term goals are, prioritize each of them, and stick with them through market ups and downs. Are you only buying property to flip? Or are you interested in generating long-term and largely passive income from rents? This factor weighs heavily on the type of ROI you should seek.
Sometimes the asset value of a property can increase faster than the rent rates in the area. In these situations, a house that appreciates slowly may actually generate more income in rent over time than a property with skyrocketing values, but high mortgage payments that eat into the capital gains income it produces.
While everyone wants the asset value of a real estate investment to increase, if you’re buying an investment property to rent, you’re also expecting to make a profit from rents as well. This complicates the ROI calculations a bit because there are far more costs to account for when you buy and hold a property to rent out.
Calculating basic ROI is a fairly straightforward formula. You take the gain on the investment minus the cost of the investment and divide that result by the cost of the investment.
ROI = (gain on investment - cost of investment) / cost of investment
For example, if you invest $400,000 in a house and later sell it for $500,000, you’d calculate the ROI as: (500,000 - 400,000 = 100,000) / 400,000 = 0.25 or 25% ROI.
When calculating ROI for the property you’re renting out, you’ll deduct all the costs of ownership from the monthly rents and divide that result by your cost basis. Then, take that figure and multiply it by 12 for the annual net profits.
For example, if you rent out a house and use a property manager to collect rent and source tenants. Your rental income is added to your capital gains, but the property management fees are deducted as costs.
ROI on real estate is impacted by more than simply buying and selling prices. The cost of your real estate investment is not simply the purchase price. Often, properties need some sprucing up to maximize returns, but this involves additional costs beyond the purchase price.
Be sure to factor in whatever else the property may need to reach its full marketing potential. A coat of paint and basic detail updates can make a tremendous impact on final sales prices, especially in markets that are hot. These costs are well worth it but need to be factored in to arrive at your final projected ROI on the deal.
If you’re fortunate enough to be able to pay cash, your real estate ROI calculation is pretty straightforward. Simply calculate your annual return—any income from the property, minus expenses—and divide that figure by the amount you paid in cash for the house.
Say you paid $500,000 cash for a house and spent $8,000 on improvements. Your total cost is then $508,000. If you then rented it out for $4,000 a month for 12 months and had utilities, fees, taxes, and upkeep costs totaling $16,800 for the year, your annual income would be ($4,000 x 12) - $16,800 = $31,200.
Now divide the annual return by the cost of investment, $508,000.
$31,200 / $508,000 = .061, or an ROI of 6.1%
When you take out a mortgage to buy a property, you have to factor the related costs into your ROI calculation. This means your total cost will include the amount of your down payment along with any closing fees. Finally, you’ll have to subtract the cost of your monthly mortgage payments from any monthly rents, so keep that in mind as well.
When you’re seeking ways to diversify your portfolio while earning a solid ROI year after year, real estate investing is an ideal strategy. However, if you’d rather avoid the endless calculations necessary to analyze property deals, Saint Investment Group is here to help.
Saint Investment Group empowers you to invest in exceptional properties that pay solid returns and provide stable income streams without dealing with properties directly. What’s better, you’ll have access to monitor performance with detailed monthly reporting and deal transparency for ultimate peace of mind. Call (323) 483-0291 today and get started.
A master in Investment, Marketing, and Capital Raising.
Nic has honed his focus on the Real Estate and debt markets with Saint Investment Group and pursues large-scale Distressed Asset purchases with his partners and syndications.