Word of the Week 'ROI Real Estate'

How to Calculate Return on Investment (ROI) for Real Estate Investments

By Marc Davis

Return on investment (ROI) is an accounting term that indicates the percentage of invested money that's recouped after the deduction of associated costs. For the non-accountant, this may sound confusing, but the formula may be simply stated as follows:

ROI= Gain from investment-Cost of investment/Cost of Investment

But while the above equation seems easy enough to calculate, with real estate a number of variables, including repair/maintenance expenses, and methods of figuring leverage – the amount of money borrowed (with interest) to make the initial investment – come into play, which can affect ROI numbers. In many cases, the ROI will be higher if the cost of the investment is lower.

When purchasing property, the terms of financing can greatly impact the price of the investment; however, using resources like a mortgage calculator can help you save money on the cost of the investment by helping you find favorable interest rates.

Let's look at the two primary methods to calculate ROI: the Cost Method and the Out-of-Pocket Method.

The Cost Method

The cost method calculates ROI by dividing the equity in a property by all costs.

As an example, assume a property was bought for $100,000. After repairs and rehab, which costs investors an additional $50,000, the property is then valued at $200,000, making the investors' equity position in the property $50,000 (200,000 – [100,000 + 50,000]).

The cost method requires the dividing of the equity position by all the costs related to the purchase, repairs, and rehab of the property.

ROI, in this instance, is $50,000 ÷ $150,000 = 0.33, or 33%.