Return on investment (ROI) is an accounting term which shows the percentage of invested money that’s recouped after the deduction of associated costs. For the non-accountant or just regular people, we could say that this may sound confusing and not that easy, but the truth is that the formula may be very easy when applied correctly, it can be simply stated as follows:
But while the above equation seems easy enough to calculate, with real estate a number of different variables, including repair/ maintenance and ways of figuring leverage – the amount of money borrowed to make the initial investment – is very important, and that can affect ROI numbers. Usually, the ROI will be higher if the cost of the investment is lower.
When purchasing property the terms of financing can very much influence the price of the investment; however, using resources like a mortgage calculator can help you save money on the cost of the investment by helping you find favorable interest rates.
So the best thing is to use an online ROI calculator.
The link for an online ROI: https://www.mortgagecalculator.org
When we talk about the calculation of ROI then There are two primary methods to do so: you can use the Cost Method and the Out-of-Pocket Method.
The Cost Method
The cost method calculates ROI by dividing the equity in a property by all costs.
Example, a property which was bought for $100,000. After repairs and rehab, which costs investors an additional $50,000, the property is then valued at $200,000, making the investors’ equity position in the property $50,000 (200,000 – [100,000 + 50,000]).
The cost method requires the dividing of the equity position by all the costs related to the purchase, repairs, and rehab of the property.
ROI, in this instance, is $50,000 ÷ $150,000 = 0.33, or 33%.
The Out-of-Pocket Method
The out-of-pocket method is preferred by real estate investors because of higher ROI results.
Using the numbers from the example above, assume the same property was purchased for the same price, but this time the purchase was financed with a loan and a down payment of $20,000. The out-of-pocket expense is therefore only $20,000, plus $50,000 for repairs and rehab, for a total out-of-pocket expense of $70,000. With the value of the property at $200,000, the equity position is $130,000.
The ROI, in this case, is $130,000 ÷ $200,000 = 0.65, or 65%. This is almost double the first example’s ROI. The difference, of course, is attributable to the loan: leverage as a means of increasing ROI.
Often, a property will not sell at its market value. Frequently, a real estate deal will be consummated at below the initial asking price, reducing the final ROI calculation for that property. Keep in mind, also, that there are costs associated with selling a real estate property: funds expended for repairs, painting or landscaping. The costs of advertising the property should also be added in, along with appraisal costs and the commission to the real estate agent or broker.
Are you interested in investing in real estate in Turkey ? check out our article: Turkey properties and the return on real estate investment
Complications in Calculating ROI
Complications in calculating ROI can occur when a real estate property is refinanced or a 2nd mortgage is taken out. Interest on a second, or refinanced, the loan may increase, and loan fees may be charged, both of which can reduce the ROI. There may also be an increase in maintenance costs, taxes of the property, and utility rates. All these new numbers need to be plugged in and the ROI recalculated if the owner of a rental residential or commercial property pays these expenses.
Complex calculations may also be required for property bought with an (ARM) – An adjustable-rate mortgage (ARM) is a type of mortgage in which the interest rate applied on the outstanding balance varies throughout the life of the loan. Normally, the initial interest rate is fixed for a period of time, after which it resets periodically, often every year or even monthly. – with a variable escalating rate charged annually through the duration of the loan.