April 3, 2023

Calculate return on investment and learn what ROI means in real estate

Return on Investment (ROI) is a metric that measures the profitability of an investment. It measures the profit or loss generated by an investment relative to the amount of money invested. ROI is expressed as a percentage, and the higher the percentage, the more profitable the investment. In simple terms, ROI tells you how much profit you have made on an investment in relation to the amount of money you have invested.

ROI is an important metric in real estate because it helps investors evaluate the profitability of a potential investment. Investors use ROI to compare the returns of different investment opportunities and to determine whether an investment is worth the risk.

There are other methods of quickly analyzing and comparing potential investment properties, including cash on cash return, cap rate, and gross rent multiplier. While these other methods are also useful for evaluating specific aspects of an investment opportunity, ROI provides a simple and comprehensive view of the investment's overall profitability.

The ROI formula calculates the profitability of an investment by measuring the profit or loss generated in relation to the amount invested.

The formula for calculating ROI is:

**ROI = (Gain from Investment - Cost of Investment) / Cost of Investment * 100**

For example, suppose you invested $100,000 in a rental property, and you earned $10,000 in rental income after one year. You also spent $5,000 on property maintenance and repairs during that year. Using the ROI formula, we can calculate the ROI as follows:

ROI = ($10,000 - $5,000) / $100,000 * 100 ROI = 5%

This means that for every dollar you invested in the property, you earned 5 cents in profit.

While the basic ROI formula is useful for evaluating the profitability of a single investment, it doesn't take into account the time frame of the investment. An investment with a high ROI over a short period of time may not be as profitable as an investment with a lower ROI over a longer period of time. The annualized ROI formula takes into account the compounding effect of ROI over the time period of the investment.

The formula for calculating annualized ROI is:

**Annualized ROI = ((1 + ROI / 100) ^ (1 / Time Period) - 1) * 100**

For example, suppose you have Property 1 with an ROI of 5% and Property 2 with an ROI of 10%. You expect to keep Property 1 for 10 years but only want to keep Property 2 for 3 years.

Annualized ROI for Property 1 = ((1 + 5% / 100) ^ (1 / 10) - 1) * 100 = 5%

Annualized ROI for Property 2 = ((1 + 10% / 100) ^ (1 / 3) - 5) * 100 = 3%

This means that Property 1 earned an average of 5% return per year over the 10-year period while Property 2 earned an average of 3% return per year over the 3-year period.

In conclusion, ROI is an important metric for real estate investors to evaluate the profitability of their investments. By understanding how to calculate ROI and annualized ROI, you can make more informed investment decisions by evaluating the profitability of investments and comparing the returns of different investment opportunities.