For most people, the idea of investing in real estate is an appealing one. After all, current interest rates are near historic lows, lending is easier than ever, and there is a shortage of high-quality investment properties.
However, many people new to real estate investing find the market’s current conditions overwhelming. What is a good time to buy? What should I invest in? What are my returns going to be?
As you can see, real estate investment seems like a fuzzy, undefined option for beginners. One thing that can help – especially in making those initial investment decisions – is knowing how a potential deal will return on investment (ROI).
So, what exactly is ROI? Simply put, it’s the rate of return you can expect from an investment – and it’s one tool that can open your eyes to what you can expect from your investment.
What is ROI in Real Estate Investing?
Real estate investors use the ROI metric to estimate the financial return on their investment. ROI tells us how much cash will be generated for each dollar invested. Real estate is a long-term investment, so the goal is to have a positive ROI, which means you will generate more revenue than you spent.
A positive ROI benefits the investor because it indicates that the investment will eventually pay off. Many investors use the ratio to see how well an investment property performs relative to the market.
How Do You Calculate ROI for Real Estate Investments?
There are three main ways to calculate ROI in real estate:
ROI = (Investment Gain − Investment Cost) ÷ Investment Cost
The first method looks at the long-run performance of the property. This includes any additional expenses associated with the property, including closing costs and fees.
ROI = Net Profit ($200,000 − $150,000) ÷ Total Investment ($150,000)
The second method considers the associated repairs, using it as a cue whether or not the investment is a good one in the long run.
ROI = (Annual Rental Income − Annual Operating Costs) ÷ Mortgage Value
The third method looks at the performance of a rental property in any given year, taking into account the income and costs associated with the property on an annual basis.
Why Do You Need to Know Your ROI for Different Variables?
When dealing with a complicated purchase like real estate, it’s essential to know your return on investment. Understanding your ROI for every variable involved in the transaction allows you to evaluate whether or not it’s in your best interest to move forward with the deal.
Get Preapproved for a Mortgage to Jumpstart Your Real Estate Investments
Getting preapproved for a loan is one of the most crucial factors for investing with confidence. Many investors don’t decide to pull the trigger on a deal because the numbers don’t add up. However, if you’re preapproved for a mortgage, you’ll know exactly how much you can afford to spend and won’t be afraid to throw down your hard-earned money on your dream property.
The Bottom Line: Take the Time to Calculate and Compare Your Real Estate Investment ROI
The ROI metric gives real estate investors a way to determine whether or not a property will be a smart investment. It also provides a way to determine the potential success of a project. By comparing the ROI of a property to the market average, you can estimate how well it will perform in the future.
Are You Looking for a Commercial Real Estate Investment Company?
If you’re interested in investing in real estate, Evergreen Investments can connect you to wealth-building opportunities with the right asset class that suit your financial goals. Get in touch with us and see how we can help you make the best decision for your future.