Owning a property can be a costly and complicated process, leaving many owners uncertain if they are truly getting the most value out of their investment. One of the most effective ways to measure the success of a property is using return on investment. Return on investment, or ROI, is how much money is gained or lost on any given investment. Several methods can be used to determine the returns on your property within property ownership. This includes standard ROI, cash flow ROI, net operating income, the out-of-pocket method, and the 2% rule. Each option gives a unique insight into the financial success of your property, serving as a helpful tool in the present and future.
Return on Investment: Sometimes referred to as the ‘cost method’, and perhaps the easiest way to calculate the return on property investments, is this simple ROI equation:
Annual Return ÷ Initial Out-Of-Pocket Expenses = ROI
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This formula shows how much the property has profited while taking into consideration how much money was initially invested.
Cash Flow ROI: Rental properties, otherwise known as cash-flow properties, produce a steady amount of cash every single month minus the necessary expenses. To evaluate a property’s cash flow ROI, use this formula:
Gross Rent – Expenses = Cash Flow ROI
This calculates how much a property has profited from an investment each month, and provides a foundation for what to expect the future cash flow to look like.
Net Operating Income: Net operating income uses the same aspects of the previous calculations, but also considers vacancy losses in its calculation.
Rental Income – Operating Expenses – Vacancy Losses = Net Operating Income
This formula can provide a more accurate picture of the property’s return if it is left vacant for a certain period of time.
Out-of-pocket ROI: This method involves examining the rental landscape, which is often the favorite method of calculating ROI for real estate investors.
Current Equity of the Property ÷ Current Market Value = Out-of-Pocket ROI
Its popularity is derived from its higher results than other ROI methods while also looking at the whole real estate picture.
The 2% Rule: This rule states that if the monthly rent of a property is at least 2% of its purchase price, then the property should be cashflow positive.
(Monthly Rent ÷ Purchase Price) x 100 = X
If X is 2% or above, the property should produce positive cash flow. If it is below 2%, then it may be difficult to make a profit from the investment.
Although evaluating the success of a property investment may seem like a difficult task, these calculations help give a clear picture of how much return the property is receiving. No matter which technique is used to evaluate the property’s return on investment, awareness of the results will make better-informed property owners now and in the future.