Due to its potential for value growth through time, real estate is frequently viewed as an ideal investment opportunity. When purchasing an investment property to rent out, you are hoping its value will rise over time and that you’ll gain rental income.
Real estate investors evaluate a property’s probable Return on Investment (ROI) before making a purchase. ROI provides a long-term estimate of the profit you might expect from rental income. But how do you calculate it? This post serves to answer that question and more!
Return on Investment (ROI): What is it?
Return on investment (ROI) calculates the amount of profit that may be made on investment as a percentage of the cost of the investment. The ROI calculation enables you to determine whether investing in a specific piece of real estate is a smart move.
Determining a meaningful and workable ROI for a property can be difficult due to the number of particular variables involved. For instance, when the investor uses a mortgage to finance the home rather than paying cash, the calculations might become even more difficult.
Why is Return on Investment Important in Real Estate?
ROI in real estate is crucial because this estimate will show you how a particular property stacks up against others of a similar type and size and whether you should invest in it. The ROI also gives you an idea of your costs, which helps you calculate the property’s net operating income (NOI). Then you can decide if anticipated earnings will be sufficient to offset those expenses.
You might be wondering what the typical return on investment for real estate is. There isn’t, however, a single, undisputed average ROI in real estate due to the large number of variables to consider, including various capitalization rates for various markets. ROI is merely a forecasted metric, not a guaranteed one. ROI ultimately quantifies the underlying risks of an investment.
How to Calculate ROI
Here are some important numbers you will have to calculate once you have gathered all the necessary data about a property and are prepared to determine the ROI:
- Net Operating Income (NOI) – The profitability of your investment is shown by the net operating income. It can be estimated by deducting your operational costs for the property from your total income.
- The Cap Rate – This is also referred to as the capitalization rate, and it aids in your ability to compare rental investment alternatives rapidly. It can be derived by dividing your NOI by the property’s price, representing your return rate.
- Cash-On-Cash Return – This gauges the anticipated return on your rental investment. The amount can be determined by dividing the property’s cost by the annual after-tax cash flow.
- Annual Gross Rent Multiplier – Referred to as the GRM, it’s a tool for estimating the return on the rental investment. For instance, it can assist you in determining whether the asking price is fair. You divide the sales price by the annual gross rent to arrive at the GRM.
- Annual Cash Flow – Net operating income minus debt equals annual cash flow. After all costs and mortgage payments are paid, this is your rental property’s annual profit (or loss).
With the above information and numerical figures, you can calculate ROI using the following formula:
The Return on Investment, ROI:
= Profit or Gain/ Initial and additional cost of investment X 100
Note that the ROI is typically expressed as a percentage. Knowing your budget and considering the potential return is essential because various investors accept different amounts of risk. A property can appear impressive, but it still includes hidden fees and costs you weren’t aware of. For this reason, it’s a good idea to analyze your potential returns when investing in real estate constantly.
Tips to Increase Your ROI
If you own or invest in real estate, you should seek practical strategies to increase the return on your investment. Consider the following:
Property Management Automation
You may eliminate a lot of manual administrative effort by automating property management procedures. Technology can never entirely take the place of property workers in terms of importance. However, because employees’ time is so valuable, they should focus more on customer service rather than performing routine chores that can be automated.
Regularly Maintain and Renovate Your Property
As time passes, your investment property will experience some cosmetic and structural degradation. You can carry out several property maintenance duties to keep your building in good shape. Maintaining your home’s current infrastructure is the best and most straightforward approach to raising its worth.
Showcase Your Property to the Ideal Clients
Contrary to popular belief, selecting the ideal tenants for your rental property can substantially impact the building’s condition and worth. To guarantee that you receive eligible applications, you must ensure that your marketing initiatives are directed toward the appropriate prospects. You want to rent to someone who is going to make consistent and timely rent payments and maintain the rental reasonably during their stay.
Reduce Tenant Turnover
Once you’ve found the ideal tenants, you’ll want to make every effort to keep them. You know that attracting new tenants costs more than keeping the ones you already have.
Lessen the Cost of Operations
Your real estate investment will have a higher return on investment (ROI) if your operating costs are kept to a minimum. Take the time to carefully review all of the expenses associated with your home, from debt to day-to-day business operations costs. Then you can decide where to make cuts.
A rental property has a different return on investment compared to other assets. Also, keep in mind that the profit margins change based on a number of factors. Your goal is to buy a property that projects strong returns. Once you’ve bought the unit, there are additional steps you can take to increase its ROI.
If you would like help calculating ROI on your investments or would like to work with a qualified and trusted property management team, turn to the experts at T-Square Properties today!