Finding Your ROI in Real Estate Deals
First of all, what is the ROI? ROI refers to Return on Investment. This ratio is used to measure the gain or losses generated relative to the amount invested. ROI is shown as a percentage.
So now that we understand the term, let’s take a look at the calculation itself as it is a very simple one.
(Current Value-Cost) / Cost
What this breaks down to is the net profit divided by the cost of the investment.
Let’s go over a simple example. You purchase a home for $100,000. After 1 year, that value has increased to 150,000. The ROI on this investment would be (150,000-100,000)/100,000=.5 or 50% ROI. This does not take into account the amount of time, so be mindful of that.
We have just discussed the most simple of scenarios but real estate ROI is hardly ever simple and includes costs and figures that need to be taken into account. These include maintenance, fees, taxes, and utilities, amongst others. From a real estate perspective, in particular, there are 2 major thought processes around calculating ROI. This is the cost method vs the out-of-pocket method. Both can take the same metrics and give completely different percentages.
The cost method measures equity in a property divided by the property costs. Let us take the first example to illustrate how this works. A buyer purchases a house for $100,000. He then adds $50,000 in renovations and the value jumps to $200,000.
This method is very similar to the cost method minus the fact that the down payment is included to measure the cost vs the value of the loan. As an example, that same loan of $100,000 only required $20,000 as a down payment. They also added $50,000 in renovations. Under this model, they have spent $70,000 and at a new market value of $200,000, the equity is $130,000.
Equity/Current Value translates to 130,000/200,000 = 65%.
While both methods are helpful, they are estimates and actual returns may be diminished due to the costs of closing, traditional deals closing under market value, and renovations needed to sell the property. With that said, this is a great tool to measure and compare all of your investments quickly, even the non-real estate ones.