Real estate investing is just like any other type of investment where there are associated risks and a return on investment (ROI). The main goal of property investors is to buy investment properties that would generate cash flow while holding them and allow them to make money (return on investment) later on in the future when they decide to sell them. If you’re a beginner real estate investor, don’t rush into buying the cheapest investment property available and expect to make a good return on it. Successful property investors estimate the expected return on investment before purchasing the investment property. Now, you might be asking “What is a good return on investment?” And “How do property investors calculate it?”
Before we answer the first question – “What is a good return on investment?” – let’s first cover some basics that every real estate investor should be aware of regarding ROI.
What Is a Good Return on Investment?: The Basics
In simple words, property investors use the return on investment to measure the amount of gain or loss of an investment property in relation to the amount of money invested in it. To measure ROI as a percentage, the basic formula used to calculate ROI is: ROI = (Net Profit/Cost of Investment) x 100.
Property investors calculate the return on investment for many purposes: it determines the profitability and efficiency of an investment property, and a real estate investor can compare the ROI of an investment property to the ROI of other investment properties (of different types and in different locations) to determine which is more financially rewarding.
The truth is that there is no straightforward answer to the question “What is a good return on investment?”. A common answer is “It depends on a number of factors”. These factors are mainly the location of the investment property, its type, size, costs of repairs and maintenance, property taxes, and others. However, there are certain percentages that expert property investors agree on – which are discussed in details below.
Before moving on to answer the question of “What is a good return on investment?”, it should be mentioned that the formula above is very general and includes a lot of unproven numbers. This is why property investors use other two more specific measures of ROI – cap rate and cash on cash return.
What Is a Good Return on Investment in Terms of Cap Rate?
In real estate investing, cap rate (short for capitalization rate) is a popular metric used to calculate the return on investment. A real estate investor uses this metric when he/she wants to calculate the ROI of an investment property that he/she paid for fully in cash (not by taking a mortgage from a bank to finance the purchase).
To measure the return on investment using the cap rate metric, property investors take the NOI (net operating income) of the investment property and divide it by the purchase price. Let’s give an example to further elaborate: Say a real estate investor purchased a $170,000 investment property, he rented it out and charged $1,500 as monthly rent, and all annual costs related to the investment property add up to $3,000. In this example, the return on investment in terms of cap rate would be:
Cap Rate = (12 x $1,500 – $3,000)/$170,000 = 8.82%
Now, let’s go back to our main question of “What is a good return on investment?”. As we said, there’s no right or wrong answer to what is a good return on investment. When it comes to cap rate, however, many experts in the real estate investing business agree that a good ROI is anything above 10%. Thus, in our example, the real estate investor is getting a good return on his investment.
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What Is a Good Return on Investment in Terms of Cash on Cash Return?
Cash on cash return (CoC return for short) is probably the most popular metric for calculating the ROI of an investment property. Property investors use this metric when they take a mortgage to finance their investment (which is the most common way of financing investment properties). To measure the return on investment, a real estate investor divides the NOI by the amount of cash actually invested (the down payment).
For example, a real estate investor purchased an investment property worth $350,000 through a mortgage. This investor put a 20% (which is what most banks require) of the purchase price as down payment ($70,000). He rented out the investment property for $1,700 monthly rent, with annual expenses summing up to $4,000. In this case, the ROI in terms of cash on cash return would be:
CoC Return = (12 x $1,700 – $4,000)/$70,000 = 23.4%
Do you think this is a good return on investment? Let’s look at the possible answers to what is a good return on investment regarding cash on cash return:
Just like the cap rate, a good ROI in relation to cash on cash return also varies depending on the type of the investment property, its location, etc. Unlike the cap rate, however, experts in the real estate investing business still disagree on a number. Some say anything in the range of 8-12% of cash on cash return answers “What is a good return on investment?” in terms of cash on cash return. On the other hand, others would not recommend buying an investment property if it doesn’t provide them with 20% of cash on cash return.
The Best Tool Determine What Is a Good Return on Investment
If you found these numbers and calculations complicated, don’t worry! Mashvisor’s investment property calculator is the best real estate investing tool that makes calculating these numbers a piece of cake. It automatically computes numbers which you enter to provide you with accurate results regarding what is a good return on investment in terms of cap rate and cash on cash return.
Mashvisor also provides real estate investors with readily calculated cap rate and cash on cash return results for thousands of investment properties and entire neighborhoods across the US real estate market.
Ultimately, with Mashvisor’s investment property calculator, property investors don’t worry about getting wrong results of “What is a good return on investment?” and ending up making bad investment decisions. On the contrary, they’ll have better chances to find the best investment properties that meet their requirements and succeed in the real estate investing business.
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Final Words on What Is a Good Return on Investment
Now that we’ve explored the possible answers to “What is a good return on investment?” in terms of cap rate and cash on cash return, these numbers together can help a real estate investor evaluate real estate investments’ efficiency and profitability to decide which property is the best one to guarantee a successful career in the real estate business.
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