Return on investment (ROI), as defined by Investopedia, is “an accounting term that indicates the percentage of invested money returned to an investor after the deduction of associated costs”. The definition may sound a bit confusing to non-accountants, but the mathematical formula for ROI is so simple that even a layman will understand it easily.
Return on investment (ROI) = (Gain from Investment – Expenses of Investment)/ Cost of Investment.
If there is still any confusion, continue reading to calculate ROI for your real estate.
Calculate your expected earnings
Start by calculating your expected earnings from the rentable real estate. Add up the money you are expected to obtain by renting out the property every month. Multiply the sum by 12 to find out the money it will bring in per annum. Do not subtract any expenses yet.
Assess yearly expenses for the property
Find out the expenses you may incur being the owner of the rentable property. The expenses pertaining to the property include monthly mortgage payments, insurance payments, taxes, maintenance and repair costs etc. Convert the monthly expenditures to yearly numbers before adding them to find your yearly expenses. Only taxes are calculated on yearly basis, rest of the expenses are all monthly. Multiply them by 12 and add to the amount of taxes. The resulting figure will show your annual expenses.
Figure out the amount you have invested
Down payments and costs for repairs and renovations before renting out an estate are regarded as investments. Whereas repairs and maintenance carried out during the lease fall under expenses. For example if you have paid $25,000 as down payment and spent $5,000 on initial repairs then your total investment on the property would be $30,000.
Calculate net operating income
Net operating income is the total amount you earn in a year minus the total expenses you incur in that particular year. To calculate the net operating income of your rentable property simply subtract total expenses calculated in Step 2 from your total earnings, calculated in step 1. Suppose your annual earnings are $9,500 and your annual expenses are $8,000, then your NOI will be $9,500 – $8,000 = $500.
Compute the ROI
Use the net operating income calculated above to calculate the return on investment (ROI). Divide the net operating income by your total investment. Multiply the result by 100 to get the percentage. Using the above example, divide the ROI would be $500/$30,000*100 = 1.6 percent.