The Magic Number: What Is Considered a Good Real Estate ROI?

Photo from Unsplash

Originally Posted On: https://www.msn.com/en-us/money/realestate/the-magic-number-what-is-considered-a-good-real-estate-roi/ar-AA1kIYtn

According to a 2023 Gallup poll, Americans see real estate as the best long-term investment available. While there’s a lot of money to be made in real estate, some investments offer a bigger return than others.

If you want to make sure that you make the most of your investment, you should calculate your return on investment (ROI). Knowing what ROIs are common in real estate and calculating your ROI will help you stay on track and make the most money possible.

So, what’s considered a good real estate ROI? Below we’ll tell you what you need to know.

There are various methods for measuring ROI in real estate. Here are the three metrics that you should consider using.

The simplest way to calculate how much money you’ve made with a real estate investment is to use a basic ROI formula.

Here’s the formula that you’ll need to use:

ROI = Profit / Investment

At the most basic level, your ROI is simply the amount you earn minus the amount you spend on the property.

If you paid $200,000 for a property and then paid an additional $10,000 in maintenance, then your investment would be $210,000. If you charged tenants $1,500 in rent every month then this would amount to $18,000 per year.

You would then calculate the ROI by dividing $18,000 by $210,000. This would lead you to .086 which would be an annual ROI of 8.6%.

One of the ways to measure real estate ROI is by checking the capitalization rate, or cap rate. This metric measures the return that a property offers over the period of a single year. The formula assumes that the property has been paid for in cash rather than through financing.

Here’s the formula that you’ll need to use to calculate the cap rate:

Capitalization Rate = Net Operating Income / Current Market Value

For example, let’s assume you buy a $300,000 home and the net operating income (NOI) is $20,000 per year after expenses. In this case, you would divide $20,000 net operating income by the $300,000 current market value to find that the cap rate is 0.66 or 6.6%.

The cash-on-cash (CoC) return is another metric you can use to calculate the ROI of a property investment. This metric looks at a property’s pretax cash flow and compares it to the total amount of cash invested. This metric can be helpful when financing is involved in a real estate investment.

Here’s the formula that you’ll need to use:

CoC Return = Annual Pretax Cash Flow/ Total Cash Invested

As an example, let’s assume you buy a property that costs $500,000. The mortgage down payment for the property is $50,000, or 10% of the total purchase price.

Let’s also assume that over the course of a year’s time, you made payments on the loan that amounted to $12,500. You also spent $5,000 in maintenance costs.

At this point, you will have spent a total of $67,500 on the property.

Then let’s say that you sell the property after a year for $550,000. After paying the remaining $437,500 for the mortgage, your cash flow would be $45,000 ($550,000 – $505,000). Your cash-on-cash return would be 51.9%. ($35,000 / $67,500 = 0.519).

So what ROI should you look for in real estate? While there are no hard and set rules, here’s a general idea of what you should be looking for based on the type of real estate investment that you make.

For residential rental properties, many investors consider a minimum of 6-8% ROI to be desirable. Investors who are a bit more experienced may want to look for an ROI of 10-12% or more to ensure that an investment is worthwhile.

For commercial rental properties, it’s best to look for an ROI of 8-12%, at minimum. Although commercial properties can be higher risk, they can also offer higher rewards as well.

Fix and flip properties often generate a relatively high return. For these types of investments, you’ll want to look for a minimum ROI of 15-20% to ensure that your time and effort have been put to good use.

There are various factors that can influence your real estate investment returns. Here’s what you should consider.

The property type you invest in can also make an impact on your returns. Remember that commercial properties are a bit higher risk but tend to offer better ROIs than residential properties do.

The location of your real estate investment can make a big impact on rental income as well as property appreciation over time. Be sure to think carefully about a property’s location before purchasing it if you want to get a great ROI.

The investment strategy that you use will also affect your ROI. You’ll want to think carefully about whether you buy a property and use it as a rental or use another strategy such as “fix and flip” or “buy and hold” to generate income.

Market conditions and basic supply and demand can have an impact on the success of your investment as well. If you decide to sell a property in a buyer’s market, for example, you may have a harder time getting a large return on your investment.

If you choose to finance a property investment, then you’ll want to think carefully about the rates. The amount of money you spend on interest and the size of your down payment will make an impact on how much money you make overall.

Paying in cash may allow you to gain the highest returns and could be well worth it if you’re able to do so.

If you want to ensure that your investments are worthwhile, consider calculating your real estate ROI. Remember that your target ROI may vary based on the type of investment that you’ve made. A 6-8% ROI may be desirable for a residential property investment, but you’ll usually want to aim higher for a commercial property investment or a fix and flip.

Investing in real estate can be a great way to build your wealth, but you’ll want to be sure to do it right. Browse our blog now to discover more helpful tips and tricks for real estate investors.

This article is published by NYTech in collaboration with Syndication Cloud.