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How to Calculate ROI for Real Estate Investments

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How to Calculate ROI for Real Estate Investments Powered By Docstoc
					HOW TO CALCULATE ROI
for Real Estate Investments
 How to Calculate ROI for Real Estate Investments


 ROI or Return on Investmentis a term to describe how much you profit from an
 investment. It is the percentage of money made on an investment after all the costs
 associated with that investment are subtracted. So, if you invested $10 and earned $1,
 your ROI would be 10%, assuming you get your original $10 back.


 The basic equation is:


 (Gain – Investment Cost) × 100%
 ___________________
         Your Cost


 Let's look at the two basic methods of applying this equation to real estate
 investments:


    1. The Out of Pocket Method


      Suppose you purchased a house for $100,000. The needed rehab was $60,000
      and the eventual selling price was $200,000. Let's also assume that the investor
      only had to come up with a $10,000 down payment and the rehab costs.


      The ROI would be:


      ($200,000 – $160,000)× 100%
      _______________________= ~57%
                $70,000

    2. The Cost Method


      Let's use the same imaginary situation, but the investor paid for everything with


                                         1
     his own money.


     The equity in the property is $40,000 (200,000 – 100,000 – 60,000= $40,000).


     The ROI would be $40,000 / $160,000 = 25% (A 40k profit on 160k spent).




The first method allows for the use of leverage, so it might seem better to borrow as
much as you can. But consider that that actual amount of money you would make
would be greater in # 2, since there wouldn't be any costs associated with the loan.
So your rate of return might be lower, but the number of dollars in your pocket would
be greater.


Which method you choose is up to you. The point is to stick to one method when
comparing different prospective investments. ROI can be an excellent tool to
determine which deal is better than another.


Other Considerations


Don't be concerned with equity in your calculations; it’s better to be concerned with
the amount of money you are left with at the end. You need to consider all your
expenses, such as:


     Property taxes that you have to pay

     Insurance while you're holding the property

     Utilities

     Interest on any loans

     Closing costs, both to buy and to sell the property

     Real estate commissions when you sell

     Mowing the grass until the property sells


                                        2
                                        Appraisal and inspection costs

                                        Costs for repairs – both materials and labor


                                   The real estate shows you see on TV rarely address all these costs. All they talk about
                                   is the purchase price, cost of repairs, and the selling price. As you can see, repair costs
                                   are only one of many costs that you may be responsible for. Those shows have
                                   nothing to do with reality. Be sure you’re subtracting all your expected costs when you
                                   do your calculations.



                                   Also consider time. Is a 40% return in 12 months better than a 20% return in 12
                                   weeks? In most cases, no, it is not. Just be sure to consider the time period when
                                   you're making comparisons.


                                   Also consider cash flow.In the case of an apartment building, your 'gain' would be the
                                   rents that you collect over the course of a year. But be sure to include a vacancy rate
                                   in your calculations. There are also greater costs associated with owning rental
                                   properties: repairs in the middle of the night, painting between tenants, advertising,
                                   carpeting, landscaping, and more.


                                   Getting an accurate ROI estimate really isn't possible in real estate. You never truly
                                   know your future selling price or how long it will take. Repair estimates can be off as
                                   well. That's why it's important to estimate high on your costs and low on the income. Be
                                   conservative and you’ll always be pleasantly surprised in the end!




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Curtis Rose is an experienced professional with extensive experience in all
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