Real estate investing for beginners comes with unique challenges but definitely reaps great rewards. After all, many people enter the real estate investing business mainly because it is one of the best ways to make money and build wealth.
When starting your career as a real estate investor, you’re going to come across a number of important terms which you must understand to succeed in the real estate market industry. This is why it’s important for property investors to do their homework before they buy an investment property!
Mashvisor offers hundreds of blogs, guides, and tips for actual and future property investors regarding anything related to real estate. In this guide, we’re going to save your time and introduce you to one of the most important terms in real estate investing for beginners – the return on investment (ROI for short). So, without further ado, let’s jump right in!
Real Estate Investing for Beginners – What Is ROI?
The return on investment is, in simple words, the annual gain you receive from the investment property calculated in the form of a percentage. This percentage could be positive (indicating that you’re making a profit off your real estate investment), or it could be negative (meaning you’re actually losing money from your rental property, which is obviously something no real estate investor aims for!). Generally, the rate of return falls into three main categories:
Real Estate Investing for Beginners – Expected ROI
The first type of return on investment is the amount of profit that property investors anticipate a rental property will generate. We use this type when the investment property has several known or expected potential outcomes, which we multiply by the probability of them occurring and then summing the results. The trick here is that we don’t actually know the probabilities of each outcome, we just expect them (hence the name).
Real Estate Investing for Beginners – Required ROI
The required return on investment refers to the necessary minimum return needed in order for the real estate investor to consider an investment property. This type requires the real estate investor to determine the cost of capital (the maximum price he/she’s willing to pay for a rental property). Investment properties are profitable if their required ROI meets or exceeds this price.
Real Estate Investing for Beginners – Actual ROI
This one doesn’t need much explaining. Actual return on investment is the actual amount of profit gained or lost from a rental property during a period of time in relation to its initial value.
For a more detailed explanation, read this blog: The Three Types of Return on Investment in Real Estate
Real Estate Investing for Beginners – Why Is ROI Important?
When it comes to real estate investing for beginners, it’s important for property investors to calculate the return on investment for a number of reasons. Without calculating the ROI, how would a real estate investor be able to evaluate a rental property and determine whether or not an investment is a smart decision? This means that the ROI helps the real estate investor analyze different investment properties and choose the best one to invest in.
One of the best ways to make money in real estate is by buying investment properties at a great price and then selling for a higher price. To determine the selling price of an investment property, property investors are required to determine the profit they aim to make after selling. Here is another importance of calculating ROI: As mentioned earlier, calculating the required return on investment allows property investors to determine the minimum profit when selling a rental property in relation to the maximum purchase price they’re willing to pay.
Calculating the ROI before buying investment properties will also provide property investors with the necessary decision-making skills needed to make smart investment decisions. For instance, if you’re making a profit from a certain type of investment property, you’d know that this was a smart decision and would probably start looking for investment properties of the same type to invest in. Similarly, if you’re repeatedly losing money from a rental property, you’d know that this was not a smart decision and would start thinking of ways to change your investment strategy and search for a better-performing investment property.
Real Estate Investing for Beginners – How to Calculate ROI?
So, we’ve established what ROI is and why it is a crucial number to estimate, but how can we calculate it? Property investors use a real estate investing tool called the return on investment calculator. This real estate tool allows you to perform accurate real estate market analysis and in investment property analysis by calculating basic metrics that indicate the profitability of investment properties. Here are the most important figures of an ROI calculator:
Real Estate Investing for Beginners – Cap Rate
The cap rate (short for capitalization rate) measures the profitability of a rental property by relating its purchase price to the income it’s expected to generate. To calculate the cap rate, divide the net operating income (NOI) of the investment property by the current market value of the property (purchase price). NOI includes the rental income before tax and property expenses such as maintenance, management, and utilities.
For example, say a real estate investor bought a $900,000 investment property, and the NOI is $125,000 per year, the return on investment would be:
Cap Rate = Net Operating Income/Purchase Price
Cap Rate = $125,000/$900,000 = 0.1389 = 13.89%
For real estate investing for beginners, the cap rate is also used to measure how risky an investment is (higher cap rate means a higher level of risk, thus higher prospected profitability – and vice versa). This helps property investors compare different investment properties and determine which one is worth their while.
Real Estate Investing for Beginners – Cash on Cash Return
Cash on cash return (or CoC return) is another metric that the ROI calculator measures. However, this method differs from the previous one in that it calculates the return on the cash actually invested in a property (not the purchase price).
When it comes to real estate investing for beginners, a real estate investor might finance investment properties with a mortgage and put a down payment instead of buying the property fully in cash. In this case, we use cash on cash return to measure the ROI in relation to the down payment only. For example, if a real estate investor has put down $60,000 as a down payment for a rental property, and his annual NOI is $15,000, the return on investment would be:
CoC Return = Annual NOI/Total Cash Investment
CoC Return = $15,000/$60,000 = 0.25 = 25%
Mashvisor’s investment property calculator is the best tool for property investors (especially those involved in real estate investing for beginners) to calculate the cap rate and cash on cash return (in addition to other metrics) and get the most accurate results possible regarding the ROI.
Real Estate Investing for Beginners – What Is a Good ROI?
This is one of the many questions in real estate investing for beginners which don’t have a straightforward answer. Different real estate experts will give you different answers. The easiest answer to this question would be “It depends” – on the size of the investment property, the location, the associated risks, etc.
Moreover, as there is more than one way to calculate the ROI, there is more one answer to this question. When it comes to the cap rate metric, many real estate experts agree that a good ROI is usually around 10%, and a great one is 12% or more. On the other hand, experts have different opinions when it comes to cash on cash return – some say that anything in the range of 8-12% is good, while others won’t consider investment properties that don’t promise them 20% ROI.
Click here to start searching for the best investment properties with the best cap rates and cash on cash return throughout the US housing market!
Real Estate Investing for Beginners – How to Improve Your ROI?
Know Your Risks
The first and best advice always given to a real estate investor is: Do your research! Thus, property investors should always measure and understand the risks that come with buying a real estate property before stepping into the real estate business expecting a high ROI.
Minimize Vacancy Rate
Having high vacancy is something no real estate investor wants; when the investment property is empty, it’s not generating any return. In real estate investing for beginners, the best way to minimize vacancies is to find great tenants who are capable of paying the monthly rent on time and are ready to rent for the long term.
Reduce Your Expenses
The next tip is to try to spend as little as possible on the investment property – within a reasonable limit. For example, a real estate investor doesn’t have to hire a professional property management to look after the investment. In addition, keeping regular maintenance of the investment property is one of the best ways to save money in the long run and improve the ROI.
Add New Amenities/Additional Services
Adding new amenities that you didn’t have before allows you to charge more rent from tenants. Don’t go overboard; add something simple like a toaster or a coffee machine. The increase in rent won’t be drastic, and gain may not seem too significant, but it will make a huge difference in the long term. You could also improve your ROI and make extra money by providing tenants with additional services, such as cleaning services or parking space. Adding amenities and services will not only enable you to improve the ROI but will also keep you ahead of competitors.
Real Estate Investing for Beginners – Conclusion
Real estate investing for beginners is a great way to make a profit through the return on investment. Understanding and calculating the ROI is important for property investors to analyze and evaluate their investment properties at different stages and determine whether or not the investment is a smart decision.
Don’t forget to use Mashvisor’s investment property calculator to measure your ROI. Mashvisor also provides you with a detailed neighborhood analysis in the city of your choosing, in addition to a complete property analysis, thus allowing you to find the best investment properties with a click of a button. Mashvisor is your best friend in real estate investing for beginners. Click here to start your search!