What is ROI?
Return on Investment is a performance measure used to evaluate the efficiency of an investment or compare the efficiency of a number of different investments. ROI tries to directly measure the amount of return on a particular investment, relative to the investment’s cost. To calculate ROI, the benefit or return of an investment is divided by the cost of the investment. The result is expressed as a percentage or a ratio
Simplicity of ROI
ROI is a popular metric because of its versatility and simplicity. Essentially, ROI can be used as a rudimentary gauge of an investment’s profitability. This could be the ROI on a stock investment, the ROI a company expects on expanding a factory, or the ROI generated in a real estate transaction.
What is the Out-of-Pocket Method for Calculating ROI?
Unlike the cost method, the out-of-pocket method incorporates the debt on the property into the calculation. So, if we use the same example above, and the property was acquired with a loan with 30% down, the initial cost would only be $300,000. Combined with another $300,000 in repair costs, the out-of-pocket costs for the property would be $600,000. Since the property is valued at $2 million, the investor would have $1,400,000 of equity. $1,400,000/$2 million = 70% ROI. This is a great example of how leverage can increase ROI significantly.
Once again, for simplification, neither the costs of the mortgage payments during the rehab period nor any rental income that may have been received if the property was partially rented out during that time is included.
ROI vs. Profit
While calculating a property’s return on investment is great, it doesn’t show us how much profit the investor(s) will actually make. This is because the property needs to be sold in order for investors to realize any profits. In addition to the fact that a property may sell for well below its appraised value, selling a property may result in a variety of costs, including broker commissions as well as appraisal and marketing costs.
How much money or profit is made on investment
Return on investment (ROI) measures how much money or profit is made on investment as a percentage of the investment’s cost. Return on investment (ROI) shows how effectively and efficiently investment dollars are used to generate profits.
Many investors use the average returns on the S&P 500 as the benchmark for a target return on investment (ROI).
Complications in Calculating ROI. When you buy property, the financing terms can greatly impact the overall cost of the investment. Complications in calculating ROI can occur when a property is refinanced or a second mortgage is taken out. Interest on a second loan, or a refinanced loan, may increase, and loan fees may be charged—both of which can reduce the ROI.
How Can You Find Properties with an Above Average Return on Investment?
There’s one way you can find properties with an ROI higher than average: using an investment property calculator. An investment property calculator searches for properties based on an investor’s input and data provided by predictive analytics. If you were to use Mashvisor’s investment property calculator, you can search for properties with the highest estimated ROI, CoC, and cap rate. The calculator can also alter searches based on various features, such as budget, investment strategy, and number of bedrooms and bathrooms
OnPoint Partners
OnPointe Commercial is a Global Real Estate Consulting Firm that is committed to crafting innovative and creative strategies that are rooted in our mission to transform communities through real estate. These projects promote economic growth. No matter the location or the community we influence positive change that produces measurable results worldwide. We teach our clients how to build wealth from commercial real estate.
