Welcome back to another Rent to Retirement blog!
Today’s topic is all about MONEY! That’s the whole reason we get into real estate investing right? We want to see great returns on our investments so that we can make our financial dreams come true. Calculating your return on investment can be a little daunting if you have never done it before but it is something you have to know how to do and understand so that you can successfully keep track of your finances and plan ahead.
First, I want to define return on investment so you know why it is so important to understand. Return on Investment (ROI):
This allows for comparison of all types of investments across the board. ROI tries to directly measure the amount of return on a particular investment, relative to the investment’s cost. Calculation: (Money invested/money
received) on an annual basis. We’ve also got a whole page on our website that you can refer back to that digs in deep on the vocabulary associated with everything returns related! You can get on our website and look for the tab that says “The Magic of Real Estate” or just simply click on the link provided here. Let’s start with a couple of numbers that you will need in order to get your final ROI numbers.
Net operating income
To get this number you take your Gross operating income
(monthly rent X 12 – vacancy rate) and subtract your total operating expenses. Operating expenses are going to include your annual property management fees, property taxes, insurance and maintenance.
Once you get your Net operating income, you want to use that number to calculate your cash flow which is the monthly income received from rent after all expenses and mortgage payment are taken out. To get your cash flow number you take the net operating income and subtract your annual principal and interest payments.
Return on Investment
Now that you understand how to calculate net operating income and cash flow, lets calculate your ROI! There are important calculations that you will want to do to see your annual returns and successfully be able to strategically grow your portfolio. COC ROI from rent income, COC ROI with depreciation, COC ROI with appreciation, and COC ROI with the tenant paying down your mortgage.
COC ROI From Rent Income Example:
To get this number you take your annual cash flow, in this case let’s say it is $3,000, and divide that by your total cash investments (if financed this is the down payment and closing costs) which in this example we will use $28,000. That will give you an ROI of 10.7% after your first year.
COC ROI with Depreciation Example:
In this example the purchase price of the home is $125,000.00. Divide that by 27.5 years (if the home is residential, 4 doors or less, use 27.5 years) totaling $4,545. Then take that number and multiply by the tax bracket that the investor is in which in this case let’s say is 28% totaling $1,272. You then divide $1,272 by your total cash investments which was $28,000.00 totaling a 4.54% ROI with depreciation for year one.
COC ROI with Appreciation Example:
To calculate ROI with appreciation you take your purchase price
of $125,000 and add the appreciation rate of the home in this
case let’s say it is 5% in the first year. This will give you
$131,250, the market value of your home after year one.
Subtract the amount that your investment property is worth
after year one from the purchase price which will give you
$6,250, the amount of equity you gained in year one. Take this
number and divide it by the total cash investments which is
$28,000 leaving you with 22.32% ROI with appreciation.
COC ROI with Tenant Paydown Example:
Take the amount of principal paid down in the first year ( you can use an amortization schedule online to find out how much that will be.) Let’s say in this case the tenant paid down $3,000 of your principal in the first year. You take $3,000 and divide it by your total cash investments which is $28,000, totaling 10.71% ROI with tenant paydown in year one.
Taking all of these returns and calculations into consideration, an investor could have around 10-14k in equity just after the first year. Just imagine after 5 years you could have 40+ thousand dollars in equity. You could then tap into a 1031 exchange, sell the property and invest in even more investment properties, allowing you to grow and diversify your portfolio in different markets. I believe educating yourself on how to properly calculate your return on investment is one of the first, most important steps in real estate investing. If you’re interested on the first steps of
how to invest in turnkey real estate with R2R please refer back to one of our earlier blogs “How to Invest with Rent to
Retirement”. When building a portfolio, you need to be able to plan ahead and fully understand each step along the way to be able to successfully reach your financial goals. I hope by reading through this information it has done just that for you.
The team here at Rent to Retirement thanks you for stopping by and catching up on our blogs. We hope the information that we provide to you is extremely useful and you can use it for years to come and to help build up your real estate investment portfolio in order to sustain your long term financial goals!