Return on investment, or ROI, is one of the key metrics investors use when evaluating real estate opportunities.
However, ROI should not be viewed in isolation. A complete analysis should also consider cash flow, financing, equity growth, appreciation, expenses, and risk.
What Is ROI?
A simple ROI calculation is:
ROI = Investment Gain ÷ Investment Cost × 100For real estate, determining the investment gain and total investment cost requires careful analysis.
Example
Suppose an investor puts $50,000 into a property and eventually generates $5,000 in annual net profit.
A simplified calculation would be:
$5,000 ÷ $50,000 × 100 = 10%This provides a basic way to understand the relationship between invested capital and return.
Consider All Costs
Your calculation should account for relevant costs, such as:
- Down payment
- Closing costs
- Renovations
- Financing costs
- Maintenance
- Property management
- Taxes
- Insurance
- Vacancy
- Selling costs
The more complete your numbers are, the more useful your analysis becomes.
ROI vs. Cash-on-Cash Return
ROI and cash-on-cash return are related but different metrics.
Cash-on-cash return focuses specifically on annual cash flow relative to the cash invested.
For leveraged properties, this can provide useful information about how effectively your actual cash investment is performing.
Use ROI as Part of a Bigger Picture
A property with a high projected ROI may still have significant risks.
Consider the quality of the property, location, financing, operating assumptions, market conditions, and your investment objectives.
Before calculating ROI, learn how to analyze a real estate investment property.
