How to Calculate ROI When Invest In Real Estate
In last week’s video, and the one before that, I shared with you the best property to invest in, my favourite, the duplex, as well as how to calculate a properties cap rate, and cash on cash return. In this video, I’m going bring it all together and show you the one calculation you need to know when analyzing real estate.... Return on Investment (ROI). So if you're not sure how to determine a properties return on investment, watch until the end of this video and you will get the exact calculation, so you to can go and instantly analyze a properties ROI.
So how do you calculate a properties return on investment?
Well, in my one video, what is a good cap rate, I talk about what is a cap rate; capitalization rate, and how to calculate it when analyzing a property. However, investing in real estate is a long term game of holding onto rental properties, allowing you to build wealth, and build equity. And building equity is what you need to figure out to determine a properties return on investment.
But how do you measure equity? Well, it’s the amount of the mortgage that was paid down over a period of time, and a properties increase in value. I know, I know, you’re probably wondering, well how do I find that out though? Don’t worry, cause I’m going to show you right now.
And I’m going to use the same property I used as an example in my last video, which again you can watch by clicking here, where the investor is looking to purchase one of my properties that I own, my side by side duplex, for $250K, which is about market value as of the end of 2018.
The investor already knows the cash on cash return it will generate, but he doesn’t know the total return on the investment, which factors in the amount of the mortgage that is being paid down each month, each year, until it is paid off and the appreciation, if any.
So let’s figure it out then. Just like the cash on cash return, where we take the Net Operating Income (NOI) less the mortgage, which we determined in my video; what is a good cap rate. The NOI is $273.28. Again, this was calculated by taking the gross rental income of $2,000, minus the properties expenses of $700, which gives us our NOI, minus the mortgage amount, of $1026.72, which you can see the full breakdown in the video. Sidenote, these are the properties actual numbers!!!
When calculating the total ROI though, we need to go a step further, and add the amount of the mortgage that has been paid down over the year to our NOI less the mortgage.
This is where it gets a little tricky, as we need to figure out this amount. One way to do this is to go online and find a mortgage calculator.
So, go to google and just type in mortgage calculator. You can choose any of them, as they all calculate the amount that the mortgage was paid down each year. Once you find on, then input the amount of the mortgage, which is $200K. Remember the investor is putting 20% down, $50K, so we subtract this from the purchase price. Leave the amortization at 25 years, but in this example, we are going to change the interest rate to 3.77%, and hit calculate. We then go over to the results here, and click on chart.
Here, it breaks down what is being paid. In the video, you will see that a portion of your mortgage payment goes to paying the interest, the cost to borrow from the bank, which was the 3.77%, and a portion goes to the principal, the $200K mortgage, which is the amount that the investor is borrowing.
Now that we know the amount of the principal that is being paid down each year, which is $4,929.50, we then can go back to our calculation and add this amount to the NOI less the mortgage. And as you can see here, once you add this in, and divide by the capital that was invested, 20% of $250K, which is $50K, your return on investment is 16.42%.
By including the amount that the mortgage was paid down, you are now comparing apples to apples when looking at other investments such as that mutual fund your financial advisor is telling you to invest in, or a stock your buddy is trying to get you to invest in. I’ll bet they aren’t getting these kinds of returns.
But wait. Investing in real estate gets even better, because there is one more item you still need to consider when analyzing a properties total return on investment. The cherry on top. The properties APPRECIATION.
So, if we were to take the exact same example, and factor in even just a 2% increase in the properties price over the past year, as you can see here, your ROI increases to 26.42%.
And to calculate the properties appreciation, all we do is take the purchase price, the $250K, multiply it by 2%, which gives us $5,000, and you then add this to the NOI less the mortgage payment, plus the mortgage paydown amount and, divide by the capital invested, the $50K, which I show you in the video above.
In case your confused on what I just said, when talking about how to calculate these financial calculations, watch this video here.
Once you do this, NOW, this is your true ROI. This is what you are going to use when shopping around where to invest your hard earned money.
And this is why I love real estate. I mean, really, A 26% ROI. Return on your hard earned money. Sure, you don’t see this return until you sell the property, but the same can be said for any investment.
So, now you know how to compare apples to apples, investing in real estate, to other investments.
But how can you do this calculation much quicker then how I showed you in this video? Well, I’ve created a buy and hold property analyzer spreadsheet, which you can download for FREE, which instantly calculates a properties return on investment, as well as the other financial calculations you need to pay attention too, such as the cash on cash return, payback period, and NOI.
WHAT TO DO NEXT: Learn How to Calculate ROI