How is success measured in real estate investing? If you’re a beginning investor with the goal of making money in real estate, this is a vital question you need the answer to. So, what is the answer? It’s using return on investment!
Return on Investment Metrics: The Only Way to Measure Success in Real Estate Investing
Return on investment (ROI), A.K.A., the rate of return (ROR), is a metric that is used to determine how successful a rental property is, regardless of any real estate investment strategies. “Success” in real estate investing is simply how profitable a real estate investment property is. ROI takes everything that influences the profitability of an investment into account. Such factors include rental income, rental expenses, financing expenses, and more.
Any sound real estate market analysis and investment property analysis require return on investment calculations. That begs some questions, such as: “How is ROI calculated?” and “What is a good return on investment?”. To answer the first question, there are three main types of ROI: return on investment, capitalization rate, and cash on cash return. As we go through each type of ROI, we will able to answer the second question.
Return on Investment (ROI)
The standard return on investment for a real estate investment property is calculated as follows:
ROI = [(Annual Rental Income – Expenses and Costs)/Property Price] × 100
By factoring in how much income a real estate investment property generates, the costs it takes to run the property, and the property’s price, a real estate investor gets a clear idea of how profitable a property truly is. What’s also special about ROI calculations is that they work for all property types and real estate investment strategies.
ROI: An Example and Good Return on Investment Range
A property costs $320,000, generates $3,000 in monthly rental income, and costs $4,000 in expenses during the year. What is its ROI?
ROI = [($3,000 × 12 months) – $4,000]/$320,000 = 0.1 = 10%
Is this considered good return on investment? Generally speaking, a ROI of 15% or more is considered good. It’s worth noting, however, that a “good ROI” can be subjective. That’s because it depends on multiple factors such as location and financing. That’s why real estate investors should focus more on what’s good or average in a given area, instead of believing it’s 15% or bust. If you want to learn about finding data on specific areas, you need to learn about Mashvisor’s investment property calculator. To do just that, check out this blog: “Investment Property Calculator for Analyzing Real Estate Investments”!
Capitalization Rate (Cap Rate)
Capitalization rate, or cap rate for short, is a more specific version of return on investment. A cap rate calculator computes this ROI metric as:
Cap Rate = (Net Operating Income/Fair Market Value or Property Price) × 100%
ROI and cap rate are very similar, except for one subtle, but important, variable: net operating income. Net operating income (NOI) is the difference between the annual rental income of a property and its operating expenses. The main difference between cap rate and ROI is that cap rate does not consider all types of real estate investing expenses as ROI does. It only considers operating expenses, which are costs associated with maintaining the property.
Cap Rate: An Example and Good Cap Rate Range
One of the best real estate investment tools out there, alongside the return on investment calculator, is the cap rate calculator. Both the return on investment calculator and the cap rate calculator are applications of the broader rental property calculator, but more on that later.
If a real estate investment property with a market value of $250,000 uses $3,000 in annual operating expenses, while earning $32,000 annually, what is its cap rate?
Cap Rate = ($32,000 – $3,000)/$250,000 = 0.116 = 11.6%
The investor of this property would definitely have a real estate investing success, since the good cap rate range is from 8 to 12%. As is the case with the good return on investment range, the good cap rate range depends on multiple factors. For more on the good cap rate range when buying an investment property, read this post: “What is a good cap rate for investment properties?”!
Cash on Cash Return (CoC Return)
The last of the main real estate investing ROI metrics is cash on cash return (CoC return). Cash on cash return is probably the most common ROI metric used when buying an investment property. To learn why, let’s turn to the CoC return calculation, which a cash on cash return calculator computes as:
Cash on Cash Return = (Before-Tax Cash Flow/Total Cash Invested) × 100%
Just as cap rate is a modified version of return on investment, cash on cash return is an edited form of cap rate. The core difference between the two metrics is the use of before-tax cash flow (BTCF) in CoC return. BTCF is merely the difference between NOI and debt service. Because CoC return includes debt service (mortgage expenses), it is more commonly used when trying to see if a property is making money in real estate.
CoC: An Example and Good Cash on Cash Return Range
The BTCF of a property is $30,000 and the total cash invested in it is $300,000. What would its CoC be?
CoC = ($30,000/$300,000) = 0.1 = 10%
Like cap rate, a good cash on cash return is from 8 to 12%. But, once again, you’ll need to find the real estate investing data specific to a certain area to truly determine what is considered good. To learn more about good cash on cash return in real estate investing, read this: “What Is a Good Cash on Cash Return?”!
Rental Property Calculator: The Real Estate Investing Tool Needed for Success
The only way to truly know if you are making money in real estate is to compute ROI metrics. As we’ve mentioned earlier, your best way to do this is to use Mashvisor’s rental property calculator. The calculator obtains the different ROI metrics for all properties regardless of property types and real estate investment strategies. It also collects other unique data about real estate investing when buying an investment property, such as an investment property analysis and real estate market analysis. To learn more about all aspects of real estate investing, including more on ROI, how to invest in multiple properties, and how to find low risk investments, continue reading our blog! To start out your 14-day free trial with Mashvisor, click here!