Every real estate investor goes into real estate with one goal in mind and that’s to make a profit. The only way to make money in real estate is to get a good return on your investments. So the question that roams around in every investor’s head is what is a good return on investment in real estate? Well, the answer is “it depends.” It sucks not having a straightforward answer. However, I can give you some possible answers to help clarify what is a good return on investment in real estate.
Related: What’s the Average Return on Investment in the US Real Estate Market?
What is ROI?
Return on investment (ROI) in real estate is a profitability ratio that measures how well your investments perform. In other words, ROI lets you know if the money you let out for your business is flowing back in as income and revenue. It’s important for every real estate investor to know if what they’re putting into their property is worth it in the end or not. To find the return on investment, divide your net revenue by the cost of your investment.
ROI = (gain from investment – cost of investment) / cost of investment
Return on investment isn’t necessarily the same as profit. ROI deals with the money you invest in the company and the return you realize on that money based on the net profit of the business. Profit, on the other hand, measures the performance of the business. Don’t confuse ROI with the return on the owner’s equity. This is an entirely different item as well. Only in sole proprietorships does equity equal the total investment or assets of the business.
You can use ROI in several different ways to gauge the profitability of your business. For instance, you can measure the performance of your pricing policies, inventory investment, capital equipment investment, and so forth.
Related: What Is a Good ROI for Investing in Income Properties?
How to measure Return on Investment from the capitalization rate formula
This technique of calculating return on investment is very common among real estate investors and can help them determine what is a good return on investment. Real estate investors depend on it to get an overall 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.
- The net operating income (NOI): This is the same as your annual cash flow. Sure enough, it is easy math, and you do not need a lot of education to calculate it. All you have to do is calculate the annual rental income and subtract the annual rental expenses. In the end, you will have the amount of annual cash flow.
- The value of the property: This variable basically refers to the current market value of investment properties.
So the overall capitalization formula is:
Capitalization rate = Net operating income/Property price x 100%
Related: Is Capitalization Rate or Cash on Cash Return the Better Real Estate Metric?
How to calculate the return on investment using the cash on cash return formula
The cash on cash return formula is another simple way if you want to know what is a good return on investment in real estate. This formula is a very precise one and is more specific than other formulas. Mainly, it does the same calculations as the capitalization rate formula does. However, the only difference is the amount of actual cash involved. 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. So the formula would look like this:
Cash on cash return = NOI/Actual cash invested x 100%
How to calculate the ROI using the return on investment calculator
Going through these calculations and measurements gets annoying, especially for new real estate investors who are trying to figure out what is a good return on investment. It is an unavoidable process if you want to invest in the best investment properties. However, the real estate technology is so developed that you do not have to do these calculations by hand anymore. Simply, use the return on investment calculator. This online tool is the best when it comes to having precise measures of the profitability of a real estate property. Using the return on investment calculator allows investors to pick a profitable investment strategy and a property type. If you are wondering where to get this tool from then go ahead and check out Mashvisor! Mashvisor’s return on investment calculator will save you the time of calculating figures and analyze the housing market. So make sure you go and check it out if you want to know what is a good return on investment!
In the end, there is no exact way to tell what is a good return on investment in real estate. It depends on many factors and each situation is different from the other. There are many methods to help you calculate the return on investment for your rental property which can help determine if you’re heading in the right direction.
Learn More: Real Estate Questions: What Is a Good Return on Investment?