Return on investment analysis (RIO) is one of the basic calculations that investors rely on to measure the financial profitability of their investments. It’s the amount of profit an investor can gain from his/her investment relative to the amount of the invested capital. Return on investment analysis is used by several economic utilities including the real estate investments domain. Any expert real estate investor should master the return on investment calculation basics, limitations, and implications. In this article, we will guide you to become one of those experts and help you succeed in your real estate return on investment analysis.
Return on Investment Analysis Advantages
Return on investment analysis (ROI analysis) has many advantages. Besides being a simple and inexpensive calculation, it’s a percentage that can’t mislead the real estate investor by shiny numbers. It gives the investor how much he/she will gain taking into consideration how much he/she spent on the investment property. To illustrate, if a real estate investor gets $100 from an investment that costs him/her $10, then his/her investment is more profitable than an investment that costs $10,000 with $1,2000 revenues. The ROI calculation formula tells the real estate investor that the return on investment in the first example is 90%, while it’s only 20% in the second example.
Return on Investment Formula
In general, return on investment analysis depends on subtracting the cost of the investment from the net profit and then dividing by the total cost of the investment. If the percentage is positive, then it’s an indication that there is a profit, but if it is negative, it means that there will be a loss. The ROI calculation formula in simple is:
Return on investment = (Net profit/Cost of investment) x 100
Net profit is calculated by = (Gross gain – Cost of investment)
For example, a real estate investor purchases a $100,000 worth property and sells it after a year for $120,000, then his/her return on investment is
($20,000/$100,000) x 100= 20%.
If the investor wants to measure the RIO of the cash flow he/she can gets from a rental property, the rents should be divided by the costs of the investment. For example, a real estate investor purchased an investment property for $200,000 and expects to sell it for $220,000 after a year. It is rented out for $2,000 a month, so the return of investment formula for the cash flow will be:
($24,000/$200,000) x 100= 12%.
Want a Higher RIO?
Real estate investors considerably rely on debt and loans to start or expand their investments. There is a way of return on investment analysis called the out-of-pocket method, in which the investors consider only the capital as the cost of investments, which leads to a higher return on investment rate. However, it’s worth mentioning that an expert real estate investor can’t ignore the interest rate of the loan. If, for example, the fixed interest rate of the loan is 5%, the loan costs should be included with the cost of the investment.
Does RIO Really Mean Profit in Selling Real Estate Properties?
Not really. The profit can’t be precisely known until the investment property is sold. It’s likely that the real estate property won’t be sold at the same price the investor projected. Not to forget the expenses of the selling process like advertising, real estate agents’ commission, and legal procedures costs. In fact, the profit is most probably going to be less than the return of the investment rate.
The Problem with the ROI Formula
There is a major flaw with the return on investment analysis formula: namely, that it doesn’t’ pay attention to time. It’s true that the percentage of the profit is a crucial point for real estate investors, but the time their investments take to pay off is important as well. The ROI analysis formula doesn’t give the investor the timeline of the investment paying off. Moreover, the ROI formula is a historical measure that includes the past revenues which may mislead real estate investors. The real estate investing world rarely stays constant, and the past profit of any investments isn’t a proof that there will be the same steady profit in the future. Even if the investment is new and the return of it is still a prediction, there is no sufficient data for the calculation to be accurate. The profits and costs aren’t clear yet, and they are only predictions that can be changed in the blink of an eye. There is another risk of manipulating the return on investment analysis formula by changing some variabies.
As it can be noticed, return on investment analysis is an easy task.The tough mission is how to calculate the cost of the investment. Any expert real estate investor knows that the cost of the investment isn’t just the cash he/she spent while buying the property. The costs include the insurance, maintenance, taxes, supplies, and other countless costs. If the real estate investor considers the purchasd price as the only cost of the investment, then he/she will get an exaggerated and misleading return on investment analysis. Hence, it’s not a mere calculation formula. It’s a complicated process that involves a precise analysis of all the factors that affect the costs and profits of the investment property. Here comes the need for an effective and trusty investment property calculator. Try Mashvisor? An excellent tool that offers return on investment analysis and much more!
The Bottom Line
Despite looking like a simple and straight forward process, return of investment analysis isn’t so. The investor should take into consideration that the calculation can be misleading if the variables aren’t fixed during all the calculations of the investment. If the real estate investor wants a higher RIO rate, then he/she can use debt and loans to finance the purchase of the investment property. On the other hand, depending on cash can lead to a lower ROI rate (but the net income will be higher). This is why the investor should use the same method of calculation while comparing different properties or the same property over a period of time to measure its progress.
Consequently, a real estate can’t only rely on the return on investment analysis formula to take important investment decisions. The analysis process should include all the factors including the changes of the property location statues and all other influential economic conditions in the country. An investment property calculator can save the investor time and effort and be reliable enough to take major decisive decisions. Thus, use Mashvisor’s investment property calculator to buy the best investment properties across the US always.