How to Calculate Return on Investment

How to Calculate Return on Investment

When it comes to thinking about how to calculate a return on investment I have to laugh because for the three or four months that we looked for our first rental property, I could not wrap my head around what an ROI was.

The concept did not come easy to me and it just drove my husband crazy as a finance guy. Over and over again he would try and explain it to me in relationship to real estate investing and needless to say it just took a bit for it to make sense to me.

First off, ROI stands for “return on investment.”

Any type of an investment that you make, whether it’s a rental property, whether it’s stocks, bonds, options, whatever it is that you’re putting your money into, the reality is that you’re investing your money to make some sort of money back.

That’s the idea of a return.

We take an initial investment and we put it into some sort of investment with the hope or assurance of that initial money generating more money.

And in most cases we all aim for our investment to generate a good return.

Now all things being equal the idea of a ‘good return’ is relative to anyone and their current financial situation and expectation of their investment.

But one of the most advantageous things about investing in rental property is that we can predict, with a level of assurance, the rate of return that a potential rental property can yield us as investors.

Let’s take a look.

We buy a rental property.

Let’s say the it cost us $20,000 to buy that rental property (this would be our down payment-a percentage of the purchase price). We’re looking to make a certain amount each month, each year that will be our return on investment.

Typically, when we talk about return on investment, it’s expressed as a percentage.

We’re not dealing with cash.

This was where I kept running into issues when I was first learning this concept. I wanted to think of everything as liquid cash comparisons and not look at it as a financial ratio.

Let’s say the stock market maybe gives you an annual roi of 7% a year.

Now there are many external factors that can contribute to that 7% a year in making it either go higher or even lower (things like earnings announcements and political issues).

The great thing about rental property is that you have a lot of control over what kind of return you get, depending on the property that you buy. You can be a stickler and really just look for properties that give you a 12%, a 15%.

Heck, we have properties that make us over a 20% ROI.

The sky is the limit when it comes to rental property. You really can (if you really bust your butt) find great deals out there.

But you have to be diligent in your analysis of deals and diligence of property to understand the total return on your investment. Ask yourself…

How long is it going to take you to recoup your money?

Let’s say you buy a property and you’re getting a 25% return on your investment which again, we have some properties that do that. It’s going to take us about four years to recoup our total investment and then everything after that is just going to be pure profit.

How to calculate return on investment

When it comes to rental property you want to use this simple roi formula.

You want to take your total net cash flow from the year, so what you actually made( less all of your expenses, all of your debt payments, debt service, etc) the pure cash flow each year.

You want to take that and you want to divide it by the total cash that you invested in your property(cost of the investment) and that’s going to give you your percentage of your return on your investment for each year.

So for example:

$6,500 (cash flow) / $38,000 (cash invested) = 17% (ROI)

It’s a simple calculation that can easily be applied to quickly qualify a potential rental property.

The truth is there are many investment calculators available online that can help you in quickly analyzing the numbers on a potential deal to see what your ROI would be.

We have a Rental Property Analyzer that you can grab for free here

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