Brandon Turner, author of The Book on Rental Property Investing, said “Wealth creation through real estate starts with correct math”. Thus, it actually emphasize the importance of Return of Investment.
A veteran investor in real estate envisions to maximize their Return on Investment (ROI). It is the indicator of profitability of investment & also the measure of the lucrativeness of it. Therefore, every property investor must know how to calculate the ROI for his/her property.
But calculating ROI for your property is a confusing task & it becomes more difficult if you are naive. Here is the complete guide to enlighten you about ROI calculations for property.
The Cost Method
The cost method is one of the easiest methods for calculating the ROI for your property.
Let us assume that a particular property is purchased for PKR. 200,000. The investor has done repairs & rehab which costs him/her PKR 50,000. Now the overall property value is raised to PKR. 300,000.
So, the Total Investment at time is:
PKR 200,000 (Actual cost of property) + 50,000 (Additional investment) = 250,000
Equity Position of the investor would be:
300,000(Current market value of property) – 250,000 (Total amount spent) = 50,000
ROI% = Equity ÷ Total investment
=50,000 ÷ 250,000
Thus, the return on investment for this property will be 20% as per cost method
Also Read : Why invest in Pakistan Real Estate
The out of pocket method
This is the most desirable method for investors as it offers higher ROI percentage. In this method, we have to focus on the actual amount spent by the investor at that moment.
Let us assume that an investor interested in buying a property valued PKR. 100,000. This time he/she have just paid PKR 20,000 as down payment of property. In addition, PKR 50,000 has invested for maintenance & repairing. The overall cost of property is raised to PKR 200,000.
For now, the total out-of-pocket amount is:
= Down Payment + Maintenance & Repairs
= PKR 20,000 + PKR. 50,000
= PKR. 70,000
Taking Equity Position of Investor as:
= PKR. 200,000 – PKR. 70,000
= PKR. 130,000
ROI% = Equity ÷ Current Market Value
= 130,000 ÷ 200,000
Calculating ROI for Rental Properties
Calculating ROI on rental property is quite different from the one mentioned above.
Let us assume you have bought a property for PKR 100,000. The overall closing cost is PKR 5000 and repairing costs PKR 5000. So the total investment in property is PKR 110,000. Now you rent out your property for PKR 1000 per month.
The total rental income or annual return is:
=Monthly income x 12
=PKR 1000 x 12
ROI% = Annual return ÷ Amount of the total investment
=12000 ÷ 110,000
There are certain factors that affect the overall ROI calculations. In real estate market, trends vary abruptly. In any market, properties sold out most of the time below-market value which will reduce the ROI. Furthermore, there are certain other additional costs including closing costs that alters ROI.
Refinancing or second mortgages on the property can also influence your ROI calculations. Lastly, while calculating the ROI, it’s significant to focus all other possible cost factor involved to guarantee the most accurate ROI percentage.