What Is ROI in Real Estate, and How to Calculate It?

What Is ROI in Real Estate, and How to Calculate It?

If you want to be involved in real estate, the acronym ROI has probably come up before. Maybe you know what it means, maybe you don’t, but ROI real estate is your biggest concern if you want to make investments in property.

The term ROI stands for return on investment. In simpler terms, ROI refers to the percentage of profit you can make on investment real estate. How to calculate ROI real estate can seem like a daunting task, but it can actually be very straightforward if you know what your numbers are and what you are getting into.

The Formula – How Is ROI Calculated For Real Estate Investments?

The formula for how to calculate ROI real estate is actually pretty simple and requires only basic math. Though it can get more complicated (more on that later), the ROI formula is not a difficult one to master, though it should be noted that it changes slightly depending on whether you are looking to calculate ROI for cash sales or rentals.

For a cash sale, you have to subtract what you spent on the property from what you sold the property for. You then divide that by what you spent on the property to get the percentage of your ROI. So, to put the ROI formula in a more math-friendly way.

The Formula for ROI

ROI = (Gain – Cost) / Cost

So, let’s say you were able to sell a property for $300,000. You initially bought the property for $100,000 and spent an additional $75,000 on repairs and upgrades. Your ROI formula would look something like this:

ROI = ($300,000 – $175,000) / $175,000

ROI = $125,000 / $175,000

ROI = 0.714, or about 71.4%

That’s not a bad little profit margin at all!

Now, for calculating the ROI on rental properties, you are going to follow a very similar formula, but your units are going to be a little different. You are going to subtract your annual cost of operation from your annual revenue and divide that by your mortgage value, or the amount you still owe on the property. Again, to make it look more like math:

ROI = (Revenue – Cost of Operation) / Mortgage Value

So, if you make $1500 a month on a rental unit, but you pay $600 on water, gas, and electric, you would multiply both the $1500 and the $600 by 12. Now, let’s say you still owe 120,000 on the home. The formula would be:

ROI = ($18,000 – $7200) / $120,000

ROI = $10,800 / $120,000

ROI = .09, or 9%

Average Real Estate Return On Investment

So, what is the average real estate return on investment? Unfortunately, due to the volatility of the real estate market, the state-by-state differences in property tax, and other chaotic factors, there is not really a consistent average ROI when it comes to real estate investments. A multitude of factors can decide an ROI, and even things like weather damage can be a factor. For example, ROI for any state in Tornado Alley is going to be different than a state with calmer weather, due to insurance factors and various sudden repairs.

If you are looking to know what kind of ROI percentage you should aim for, most real estate investors will only invest in properties that can show a 10% or greater potential ROI. Any percentage under that tends to not really be worth the risk and, make no mistake, real estate is incredibly risky.

Various Factors to Consider When Calculating Costs

When assessing the cost of a property, there may be more factors to consider than initial purpose and repairs. Insurance, home owner’s association fees, general upkeep, property insurance, and even acts of God are all things that must be considered when figuring out what the costs of your property will be. It is even worth considering what a state’s property taxes might be, or even what you might pay on capital gains taxes.

If you are trying to calculate what your ROI might be if you change to an adjustable-rate mortgage, that is likely going to require some mathematics beyond what your basic calculator can do. You’ll likely need to purchase specific software made for calculating such complicated formulas.

You may also want to factor in tax breaks and credits that you can receive for purchasing properties, as some states and local municipalities crave the business and will incentivize investment in their areas.

ROI real estate is not so difficult it is impossible as long as you have all your costs and revenue streams properly assessed. Though there is no perfect, universal way to calculate ROI, you can get a solid idea of what a real estate property is worth if you put the proper work in.

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