The best real estate investments always have the best return on investment. However, what is it and how to calculate return on investment for a property?
For the most profitable real estate investments, an investor must learn how to calculate return on investment. This measurement tool is the best when it comes to evaluating the performance of an investment property. In other words, calculating the return on investment determines whether you make money in real estate or not.
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In order for you to understand the importance of this measure, you must know the advantages of it. First of all, learning how to calculate return on investment will help you make the right decisions. What we mean by this is that return on investment contributes to your location, investment strategy, and property type decisions as these are the elements of the best investment properties.
Now, to learn how to calculate return on investment, know that there are two formulas to go about it. They are the capitalization rate formula and the cash on cash return formula. Both are great measurements even though they operate differently.
How to calculate return on investment: The capitalization rate formula
This method of calculating return on investment is very popular amongst real estate investors. Commercial real estate investors depend on it to get a general idea of a property performance. Therefore, they are always able to choose the best investment properties that actually make money for them. This simple return on investment formula uses the net operating income of a property and divides it by the market value. Here is a more in-depth look at the two variables:
The net operating income (NOI): The NOI is the same as your annual cash flow. Sure enough, it is simple math, and you do not need a bunch of education to calculate it. All you have to do is calculate the annual rental income and deduct the annual rental expenses. You will have the amount of annual cash flow as a result.
The value of the property: This variable simply refers to the current market value of investment properties.
Therefore, the capitalization rate formula looks like this:
Capitalization rate = Net operating income/Property price x 100%
Note that the capitalization rate formula is a generic one. It is great for getting a quick estimation of return on investment for a certain property. Moreover, this measure does the calculations regardless of the ways you choose to finance your investment properties.
How to calculate return on investment: The cash on cash return formula
The cash on cash return formula is another easy way if you want to learn how to calculate return on investment. This formula is a very accurate one and is more specific than other formulas. Basically, it does the same calculations as the capitalization rate formula does. However, the only difference is the amount of actual cash involved. Remember, we said that the capitalization rate does the estimation regardless of how you finance your investment property. Meanwhile, the cash on cash return formula only takes into account the amount of cash involved.
To make it easier to understand, here is an example:
Jack bought an investment property worth $200,000. He put a 10% down payment ($20,000) as well as the other expenses such as the closing costs worth $4,000. The annual rental income the property generates is $15,000, and the annual expenses are $5,000. How to calculate return on investment through cap rate and CoC return?
Cap rate = NOI/Property price x 100%
cap rate = ($15,000 – $5,000)/$200,000 x 100% = 5%
Cash on cash return = NOI/Actual cash invested x 100%
CoC return = ($15,000 – $5,000)/($20,000 + $4,000) x 100% = 41.6%
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How to calculate return on investment: The return on investment calculator
Going through these calculations and measurements gets overwhelming, especially for beginner real estate investors. It is an inevitable process if you want to invest in the best investment properties. However, the real estate technology is so advanced that you do not have to do these calculations manually anymore. Simply, use the return on investment calculator. This online tool is the best when it comes to having accurate measures of the profitability of a real estate property.
With the help of a return on investment calculator, you will be able to take your business to a whole different level. You will not only have numbers but also facts. These facts are based on comparative market analysis. Therefore, they will help you compare various investment properties located in the same area. In fact, using a return on investment calculator is the easiest way to pick the most profitable real estate investments, always.
Using the return on investment calculator will also allow you to pick a profitable investment strategy and a property type.
Now, if you are wondering where to get this amazing tool, then go ahead and check out Mashvisor. Mashvisor’s return on investment calculator (also known as Mashvisor’s investment property calculator) will save you the pain of calculating figures and analyze the housing market. It will also give you access to the latest real estate market trends. So, make sure you get the best tools from the best sources!
Related: The Importance of Real Estate Comps and the Best Way to Get Them
How to calculate return on investment: What is a good return on investment?
It is hard to give an exact rate of a good return on investment. However, whether you use the capitalization rate formula or the cash on cash return formula, anywhere around 8% and above is considered a good return on investment. Of course, with the cash on cash return formula, the less cash you invest the higher return you get. So, it would be a better idea to get an external source of financing. As for the capitalization rate, it does not matter. After all, it calculates the return on investment regardless of the financing strategy.
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