Real estate investors, stock fans, commodity traders, and cryptocurrency aficionados all tend to care about one thing: return on investment. Every different investment class tends to have slightly different price targets, strategies, and communities. Despite this, every investor looks to receive the highest returns on their investment.
Calculating returns when dealing with stocks, commodities and even cryptocurrencies tends to be a rather easy affair. One simply takes the price of the asset when bought and compare it to its current price for unrealized gains or sale price for the actual returns. If the result is positive it is profit, if it’s negative it’s a loss. While things can get a bit more complicated when dealing with complex financial products such as options or derivatives, it is generally pretty straightforward.
Real estate investments on the other hand can be a bit more complicated to calculate. There are many different moving parts and things that can impact the profitability of a real estate investment.
Calculating Returns in Real Estate
The first thing to list on the excel sheet of expenses is the purchase price of the home. Then list all renovations, repairs, and additional expenses. One should also take into account whether the home was purchased with a mortgage or in a cash-only deal. While a mortgage makes a home much more affordable for an average investor, the interest payments will make it a bit more expensive. The interest rates may vary and depends on the type of mortgage the buyer agrees on but will likely be around In addition to that, add insurance payments, HOA fees if applicable, property manager’s fees, and taxes. A property manager generally charges 8-12% of monthly rental fees although some may agree to a flat fee.
While rare in today’s housing market, months, where the property is vacant, should also be an expense. According to the Federal Reserve, vacancy rates in the United States stand at 6.8% on average but tends to be lower in urban areas.
As for profits, one should list months where the property is occupied and rent checks are coming in.
In addition to monthly returns, there are also changes in the property’s valuation that one need’s to calculate.
Changes in Property Valuation
The prices of residential property tend to change year by year. Generally the price increases, with a small exception of years where the housing market faced a correction. This has been noted during the 2008 housing crisis, but since has generally returned to form. Currently, between the years 2021-2022, we’ve seen a massive increase in housing prices in the United States. In some areas, the average price of housing has increased by as much as 50% in the past year alone.
The best way to calculate the current price of your property is to get a qualified property appraiser to review the property. As professionals, they will likely be able to give you the best estimate regarding a property’s fair market value. This will usually cost the investor between $300 to $500 on average. There are a few alternatives though. While a lot less accurate, one can ask a Realtor or get a rough estimate from Zillow.
Once you have an estimate, one can factor it into unrealized financial gains, or paper profits. Keep in mind that it is only profit if sold or taken advantage of. If the home has gained a substantial amount since initially purchased, some investors may want to consider a HELOC or cash-out refinance. Then the investor may use some of the funds to further expand their portfolio.
Annual Returns & Taxes
Taxes play a part in the profitability of every investment. Whenever any type of investor makes a profit, the government tends to swoop in for a piece of the profits. This is true even in regards to real estate. The difference is, that many of the expenses can be “written off” and be refunded in the form of a tax return.
Clever real estate investors may want to make use of a good certified public accountant or CPA. Certain expenses, such as repairs, travel, and renovations can be refunded. This can greatly impact annual returns at times. This can help improve profit margins at times by thousands of dollars, if not more.
Calculating the ROI
When dealing with real estate, calculating ROI is a bit more complicated. This is because you will need to calculate the estimated change in home valuation, and income/expenses as a rental unit separately. As such 2 separate calculations are needed. The calculation is the same however.
ROI = net return on investment / cost of investment x 100%
By using this basic calculation a real estate investor can easily see how much returns they have received annually.
Expand Your Portfolio
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