How to Calculate ROI for Real Estate Investments

When you start investing in real estate, you start to pick up that there’s a lot of analysis involved. Thankfully, we have the tools to automate much of the analysis, but that doesn’t mean you should go into your investments blind to the structure of these calculations. And one of the most important calculations is return on investment (ROI). This helps you make informed decisions by providing the formulas for profitability. So how does one calculate ROI in real estate investing?

Understanding ROI in Real Estate Investing

In the world of real estate, ROI correlates to the percentage of profit earned from a property relative to its cost. As an investor, when you calculate ROI you are able to quickly compare different properties and investment strategies. This way, you can find the most lucrative opportunities relative to costs.

Steps to calculate ROI in real estate

1. Determine the total investment cost

The first step in calculating ROI is determining the total investment cost, including your total upfront investment in the property. The initial investment is the estimated capital needed to purchase the property. This amount includes your down payment, the cash portion of the property price paid at the time of purchase. When using leverage, it represents a portion of the purchase price, while for an all-cash purchase, it covers the entire property price. It also includes additional financing, loan and acquisition fees, closing costs, and agent commissions. Repair costs following inspection, bringing a residential property up to code, and any immediate rehab work are all part of the immediate cost required to purchase the investment property.

An example of this is purchasing a property for $400,000, with an additional $50,000 for all the other costs. This makes the total investment $450,000.

2. Calculate the net annual income

The next step is to calculate the net annual income generated by the property. To calculate yearly net income or cash flow, you’ll consider total rent, operating expenses, all and any management fees, utilities, and taxes. So, your net annual income will be your gross rental income after deducting property taxes, property management fees, rental vacancy rates, reserves for repairs and maintenance, capital expenditures, and loan payments. So, if you pull $30,000 in rental income, and all your expenses run about $5,000, your net annual will be $25,000.

3. Compute the annual ROI

Now that you have the total investment cost and net annual income, you can calculate the annual ROI with this formula:

ROI = (Net Annual Income / Total Investment Cost) x 100

So with the pretend numbers above:

ROI = ($25,000 / $450,000) x 100 = 5.55%

This means the annual ROI for the property is 5.55%.

Additional factors for accurate ROI calculation

Appreciation

Property appreciation can and will impact your ROI. Appreciation is plainly the increase in the property’s value over time. Which is what you want. Unlike automobiles, property appreciates when you buy the lot, not decreasing when you drive off it. To account for appreciation, you need to estimate the property’s future value and factor it into your ROI calculation.

So let’s say that your property appreciates by 3% annually, so your one year value would be calculated like this:

Future Value = Purchase Price x (1 + Appreciation Rate)

Future Value = $450,000 x (1 + 0.03) = $463,500

So let’s go ahead and include appreciation in the ROI calculation:

ROI = [(Net Annual Income + Annual Appreciation) / Total Investment Cost] x 100

Annual Appreciation = Future Value – Purchase Price

Once again using our pretend (but very realistic) numbers:

Annual Appreciation = $463,500 – $450,000 = $13,500

ROI = [($25,000 + $13,500) / $450,000] x 100 = 8.55%

However you split it, this ROI adjustment accounts for all types of rental income and property appreciation.

Appreciation

When you borrow capital, that’s called leverage. This could be a mortgage or other kind of loan. Leverage can both amplify your gains and increase your risk, because you now owe interest on whatever you borrowed. So now we have to work leverage into our ROI calculation. 

To do this, we’d consider the down payment as an actual investment cost, including mortgage interest within the operating expenses column. It sounds like a lot, but when we look at the formulas, it’s really just another line of quick math. 

So let’s assume you made a 20% down payment on the $450,000 property ($90,000) and financed the rest, you’d adjust your ROI calculation like this:

Total Investment Cost (with leverage) = Down Payment + Closing Costs + Renovations = $90,000 + $15,000 + $35,000 = $140,000

Net Annual Income (with mortgage interest) = Gross Rental Income – (Operating Expenses + Mortgage Interest)

If the annual mortgage interest is $10,000:

Net Annual Income = $25,000 – ($5,000 + $10,000) = $10,000

ROI = ($10,000 / $90,000) x 100 = 11.11%

This higher ROI is an example of the impact of leverage illustrating how when you borrow capital for your initial investment, you can ultimately increase your returns.

Maximizing ROI with Privy.Pro

Understanding and calculating Return on Investment (ROI) is crucial in making wise real estate decisions. Privy simplifies this process by providing real-time investment analysis and comprehensive data essential for evaluating the profitability of properties, comparing various investment opportunities, and making informed strategic decisions to enhance your investment portfolio.

Here’s how Privy revolutionizes ROI calculations for investors:

1. Automated Comping: Utilizing advanced technology, Privy automatically gathers comparable property data, enhancing the accuracy of your investment analysis.
2. Investor Comparative Market Analysis (CMA): Privy delivers detailed CMAs for every property that includes on and off-market data, as well as data crucial for determining the after-repair value (ARV) of properties—a key component in projecting potential ROI.
3. Cost Analysis Tools: By providing historical cost data for properties, Privy helps investors forecast total investment costs more accurately, facilitating precise ROI calculations.
4. Real-Time Data Access: Investors gain access to up-to-the-minute market data across MLS listings, public records, rental, and lending data, enabling swift, informed investment decisions crucial for ROI calculations.
5. Performance Tracking: Monitor the ongoing performance of investment properties with Privy’s tools to track rental cash flow, property appreciation, and market changes—all vital for understanding your investment’s ROI.

Integrated ROI Calculations: Combining all these data points, Privy’s platform automatically computes ROI, considering purchase prices, renovation expenses, potential selling prices or rental income, and ongoing costs.