Understanding ROI: How to Calculate Profitability in Real Estate
ROI, as in a profitable return on investment, is one of the major reasons why people invest in real estate in the first place.
As a lucrative and long-term investment, real estate can give you a steady income and an even higher appreciation value over time.
Yet, that’s not the only factor that is taken into account when we calculate the total ROI of a real estate asset.
On a deeper level, factors such as tax deductions, loan interest, the location of the property, and the cost of repair and maintenance can also impact the overall return or profit.
However, to understand, we can simply put it as the difference between the net profit and the cost of investment. For a better grasp of the whole concept, let’s take a closer look anyway.
How to calculate ROI in real estate?
Calculating the return on investment in real estate is all about comparing the current value of your property against the initial cost of purchase while considering all the relevant factors.
As such, there are numerous ways to calculate the same.
Basic ROI Calculation
While the basic formula for real estate ROI calculation is,
Real Estate ROI = (Net Profit/Total Investment) X 100.
Upon including all the relevant factors in the equation, it becomes pretty much like this-Net ROI = (Income + appreciation + tax benefits/purchase cost + maintenance + other charges) x 100.
In layman’s terms, your net profit is the total revenue you make on your property after taking care of all the expenses.
Similarly, your total investment will include the initial cost, as well as the additional costs of maintenance, renovation, and so on.
For example, if your real estate were bought at Rs 50,00,000 with additional expenses of Rs 5,00,000 for renovation and closing, the total investment would be Rs 55,00,000.
Assuming a rental income of Rs 6,00,000 and annual expenses, including taxes, maintenance, and management costs of Rs 1,00,000, your net profit would be Rs 6,00,000 – Rs 1,00,000 = Rs 5,00,000.
Put the final value into the formula, and we get-ROI = (5,00,000/ 55,00,000) x 100 = 9.09%.
Along with this simple and basic calculation process, there are other ways to get an estimate of your current ROI.
For instance, cash-on-cash return is mostly suitable for calculating the ROI of mortgaged or financed properties.
Cash-on-Cash Return (mortgaged/financed properties)
Since mortgaged properties come with their interest rates to bear, it can significantly affect the overall cost and return of your real estate investment.
When calculating your ROI based on cash-on-cash, you have to consider the actual cash that’s being invested.
Also known as the annual cash flow, it is the net amount of profit that remains after paying for the monthly mortgage and operating costs.
Annual Cash Flow = Net Operating Income – Mortgage or loan EMI. (Calculate your EMI in a few easy steps right here).
Moving on, the total cash invested in a mortgaged property would be calculated as the sum of the loan’s down payment and the cost of closing and renovation.
As such,
Total Cash Invested Here = Down Payment + Closing Costs + Renovations.
Once you have that, you can use the following formula to derive the ROI-
That is,
Cash-on-Cash = (Annual cash flow/Total Cash Invested) x 100.
Cap or Capitalization Rate Calculation (income properties)
The capitalization rate, another term to evaluate the overall profits of an income-generating real estate, applies to properties bought to generate income without any financing or loan whatsoever.
It can also compare the cap rates of different properties in the same real estate market.
In either case, to find the capitalization rate of your real estate asset, here’s what you need to do-
Cap Rate = (Net Operating Income/Initial Cost) x 100.
Net operating income (NOI) is the overall income you make after deducting operating expenses.
Therefore, if the NOI is Rs 5,00,000, and the total purchase price is Rs 55,00,000, then the cap rate in this particular scenario would be –
Cap Rate = (5,00,000/ 55,00,000) x 100 = 9.09%.
Appreciation-based ROI
This method is particularly useful when planning to sell your property and want to factor the current appreciation value into the equation.
The appreciation value of your real estate is calculated as the difference between the selling price and the initial cost of purchase.
That said, the formula becomes-
ROI = (Appreciation + Cash Flow/Total Investment) x 100.
Key Points to Remember
- These calculations give you a general estimate of your real estate ROI, which can be a bit up or down compared to the current state of the market.
- For financed or mortgaged properties, you should use the cash-on-cash return formula.
- To compare different properties, you can use the cap rate-based calculation.
- Likewise, you can use the appreciation-based ROI calculation technique when planning to list or resell your property.
Final Thoughts
As a crucial aspect of investing in a real estate property, expecting a good return on investment (ROI) is the least we can do.
At Shafalya Infra, we understand that, and that’s why we take no prisoners when it is about ensuring the best return to our clients on their real estate investments.
With years of experience as one of the leading real estate developers in Ahmedabad, whether residential or commercial, Shafalya is all in to secure the most profitable deals for our investors.
For more information on our ongoing and upcoming projects and to get an up-close and expert real estate ROI analysis, contact us now. We’d be happy to help!