When you look for ways to put your money to work, real estate may catch your eye as a source of potentially big profits. Whether you buy a home to live in or purchase commercial real estate, calculate your return on investment. ROI can include rents paid by tenants on houses, duplexes, apartment buildings and office buildings. ROI also encompasses appreciation in the value of property, including a home, commercial buildings and unimproved land.
ROI with Leverage
If you put $20,000 down on a property worth $140,000, your investment is $20,000. Don't make the mistake of counting the full amount as the value as your investment. Real estate investment allows you to leverage your money. That is, you control a much larger value by putting down a smaller percentage on the purchase. When you pay a down payment on a home, land or commercial real estate, you receive all of the ROI from that property. A comparable investment in stocks, for example, might produce a return of 15 percent. For a $20,000 investment, 15 percent is $3,000. If your property worth $140,000 appreciates 15 percent, the increase in value is $21,000. Calculate your ROI by dividing your gain by your investment and multiply by 100. In this case, 21,000 divided by 20,000 times 100 shows that your leveraged investment produced a 105 percent ROI.
ROI Using Capital Gains
Capital gains come from an increase in the property value. Even if you don't sell a property, you can estimate its current value vs. the original value. Use comparable properties in the local area for your estimate. If you prefer, you can hire a professional appraiser. Capital gains apply to any type of real estate, including a home, unimproved land or buildings you rent to tenants. To calculate ROI using capital gains, determine how much the property has appreciated in value. For example, if you invested $20,000 in a property and it went up $10,000 in value, divide 10,000 by 20,000 and multiply by 100 and you find you made a 50 percent ROI.
ROI Using Income
If you rent out property, determine your income from the property by adding up the rents your tenants pay. Multiply by 12 to find your annual gross income from the property. If you buy unimproved land, you will only have income from it if you lease it out to a company to build on, or for grazing, hiking, hunting or riding all-terrain vehicles. Income does not include appreciation in value, so some unimproved land may not offer you income. If you do have income, divide your income figure by your investment and multiply by 100. For example, if you make $5,000 in income from a property you invested $20,000 in, divide 5,000 by 20,000 and multiply by 100. The result shows a 25 percent ROI.
ROI After Expenses
Your down payment may not be your only investment in the property. If you make major repairs or perform renovations, add those costs to your original investment figure to get a total investment. Don't count small repairs such as fixing hinges or stopping a faucet leak. Your investment expenses include any repairs you make that improve the value of the property, such as roof repairs, foundation repairs and kitchen remodeling, to give a few examples. Add in the amount of the mortgage principal you pay down. To calculate ROI taking expenses into account, find your gross profit, then subtract your down payment, major repairs and principal payments. Divide the resulting figure by your investment and multiply by 100. For example, a property that provides $21,000 gross profit with $11,000 in expenses made a net profit of $10,000. If your original investment was $20,000, the ROI is 50 percent.
If you invest in a property that is leveraged (you make a down payment but get all the capital gains from the full value), produces income and incurs expenses, you need to combine all of your factors into one formula: ROI equals capital gains plus income, minus expenses, divided by your investment. For example, if you had $10,000 in capital gains plus $5,000 in income, that totals $15,000. Subtract expenses of $2,500 and your net figure is 12,500. Divide that by an original investment figure of $20,000 and multiply by 100, and you find that you made 62.5 percent ROI in this example.
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