Calculating the return on investment (ROI) for an investment property is essential for determining its profitability and evaluating its potential as an investment.
Here’s how to calculate ROI on investment property
Determine the Initial Investment:
Start by calculating the total amount of money invested in the property. This includes the purchase price of the property, closing costs, any renovation or repair expenses, and other acquisition costs.
Estimate Annual Rental Income:
Next, estimate the annual rental income you expect to receive from the property. This can be based on market research, comparable rental properties in the area, or historical rental data if the property is already rented.
Calculate Annual Expenses:
Determine the total annual expenses associated with owning the property. This can include property taxes, insurance, maintenance and repairs, property management fees (if applicable), utilities, HOA fees (if applicable), and any other recurring expenses.
Subtract Annual Expenses from Rental Income:
Subtract the total annual expenses from the annual rental income to calculate the property’s annual net operating income (NOI). The formula is:
NOI = Annual Rental Income − Annual Expenses
Calculate Cash Flow:
Cash flow represents the amount of money you have left after paying all expenses associated with the property. It’s calculated by subtracting mortgage payments (if applicable) from the NOI. If the NOI is greater than the mortgage payment, you’ll have positive cash flow; if it’s less, you’ll have negative cash flow.
Determine the Total Return:
To calculate the total return on investment, consider both the cash flow and any appreciation in the property’s value. Add the annual cash flow to any increase in the property’s value over the holding period.
Calculate ROI:
Finally, divide the total return by the initial investment and express it as a percentage to determine the ROI. The formula is:
ROI = (Total Return / Initial Investment) × 100%
Keep in mind that ROI calculations should also consider factors like vacancy rates, potential rental increases, and future market trends. Additionally, it’s crucial to understand that ROI calculations provide estimates and projections and may not accurately reflect actual returns due to unforeseen expenses or fluctuations in the real estate market.