How to Calculate Real Estate ROI

Buying and selling real estate has long been considered one of the most effective and reliable forms of generating income for professional investors. Whether you live in a rural area or a dense urban metropolis, you can use real estate as a tool for growing wealth and creating a passive income stream that will endure for years to come. One of the most fundamental elements of successful real estate investing is being able to calculate the anticipated return on investment, or ROI, for a given piece of real estate. Fortunately, you can use a series of simple steps to help calculate real estate ROI and ensure that you have the information you need to make proactive decisions in this dynamic environment.

TL;DR (Too Long; Didn't Read)

Depending upon the specific real estate investment platform you are using, you can calculate your ROI using a variety of simple mathematical formulas.

Basics of Real Estate Investing

For many individuals, the idea of pursuing a career as a real estate investor is simultaneously exciting and intimidating. The prospect of securing huge profits from lucrative sales is matched with the perceived risk inherent in all real estate transactions, making this particular professional endeavor appear equal parts mysterious and dangerous. The reality of the situation couldn't be farther from the truth. In fact, real estate investors typically use a few time-honored techniques and strategies in order to ensure that they reap the greatest possible benefits from their efforts.

Generally speaking, your average real estate investor will target one of four particular markets, those being real estate investment trusts, referred to as REITs, online platforms linking investors with property owners, rental properties and the so-called "fixer uppers," which can be upgraded and flipped for a profit. Of the investment routes mentioned here, only the real estate investment trust allows investors to take an active role in the real estate markets without actually owning property.

Understanding the Fundamentals of REITs

A real estate investment trust is closely parallel to a mutual fund that exists in the world of real estate investing. When you invest in a REIT, you are essentially placing money in the hands of a company that already owns a portfolio of commercial and residential spaces. As these trusts generate wealth, investors are paid dividends proportional to their investment size.

Generally speaking, REITs are divided into two primary groups: publicly traded REITs and nontraded REITs. As you can probably imagine, the main difference between these two trusts is the means by which shares are bought and sold. Publicly traded REITs offer shares for purchase on exchanges that closely resemble modern stock markets, and investors can buy and sell shares in these trusts just as they would shares in any publicly traded company. With that in mind, the price of a publicly traded REIT share will fluctuate according to current supply and demand.

Individuals can also avoid buying and selling REIT shares entirely by investing in a mutual fund that specializes in these trusts. For those who do not consider themselves experts in this particular arena, buying mutual fund shares and leaving the actual work of researching and picking REITs to professionals could be the best possible option.

REIT Potential ROI

When it comes time to evaluate the potential ROI of this investment, all an investor needs to do is evaluate the historical performance of the fund and determine whether or not these figures match their own financial goals. While past performance is obviously no guarantee of future results, this information could prove to be illuminating.

Nontraded REITs and Liquidity

Unlike publicly traded REITS, shares of nontraded REITs cannot be purchased through exchanges. Nontraded REITs carry their fair share of advantages and disadvantages.

Perhaps the most important factor to consider when it comes to nontraded REITs is liquidity. Because these shares are not available through indexes, the process of selling them is significantly slower than publicly traded REITs. Additionally, the fact that these shares have such a narrow secondary market means that investors may have to pay steep fees in order to obtain shares. Fees close to 15 percent are actually quite common.

Nontraded REITs Expiration

As part of their design, nontraded REITs will often include an embedded timeline. When the given timeline expires, the trust must either become publicly listed or liquidate its assets entirely. This type of ultimatum ensures that investors will eventually see some form of profit/loss realization instead of being forced to hold onto these shares indefinitely.

Transparency is somewhat limited when it comes to nonpublic traded REITs. The trust has no obligation to divulge its investment strategies to shareholders, meaning that it can be difficult at times for investors to predict what type of returns they are in line to receive.

Perks of Online Platforms

Far from the world of REITs is the high-energy, internet-driven world of real estate investment networking. A growing number of real estate crowdfunding platforms entering the marketplace have virtually upended more traditional paradigms, in which investments were often limited to more exclusive gatherings of business professionals.

Websites such as Groundfloor, CrowdStreet and Small Change are perfect examples of online real estate investment platforms where individuals can peruse available investment opportunities and distribute their funds as they so wish. While these particular platforms are open to individuals across a diverse spectrum of income levels, more exclusive services require minimum investments of $10,000 to $100,000. Depending on your specific interest, you may find that these websites allow for an unprecedented degree of access.

In many cases, available investment properties will include their unique terms with regards to investment timelines and minimum investment amounts. Investors can review this information to determine for themselves what the anticipated ROI may be for the property or properties they have set their sights on.

Understanding Average Yield on Rental Property

Rental properties continue to be a "go-to" source of income for real estate investors. Calculating the average yield from a rental property is as simple as taking the profit derived from the property (total income - cost of investment) divided by the investment cost of the property. The resulting answer, multiplied by 100, is the percentage-formatted yield from the property. In general, real estate professionals consider a yield of 10 percent to be good, while any yield over 12 percent is often considered exceptional.

Of course, a variety of factors come into play when discussing rental properties, which makes proper research and consultation critical for all investors seeking to place their money in these assets. Many investors maintain ROI on rental property spreadsheets to track their efforts over time.

Fixer Uppers and Investment Returns

If you are in the business of buying houses, upgrading them and then selling them, the term "flipper" is all too common. Real estate flippers will typically seek out properties in emerging neighborhoods that they can buy for a low price and then sell for a significantly higher price point.

Calculating ROI from real estate flipping is as simple as subtracting the total sum of expenses that went into the purchase and upgrade of the property in question from the agreed-upon sale price of the flipped property. Then, divide this resulting figure into the purchase and upgrade expenses, and multiply the final answer by 100 to get the percentage rate of return.

For example, if the property sold for $250,000 and the sum of total of the purchase and upgrade was $230,000, your first calculation should be $250,000 - $230,000, which equals $20,000. When you divide this sum by the original purchase and upgrade price, the resulting figure is .087. Multiply this by 100 to receive a percentage-formatted ROI of 8.7 percent.

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