The idea of buying investment properties and watching cash flow from them into your bank can no doubt be exciting. However, the process isn’t that simple.
If you want a prospective income property to actually produce income for you, it’s critical that you determine what the return on your investment, or ROI, will be first. This includes your return on time. If the potential ROI looks good, then you can feel good about moving forward with the deal. If not, you can avoid financial heartache.
The question is, how exactly do you go about calculating real estate investment returns?
Calculating Your ROI
When you’re trying to calculate your cash-on-cash return, you need to look at a couple of numbers. The first one is the cash flow you’ll generate based on the initial investment. As an example, let’s say that a house you buy will end up generating a couple of thousand dollars each year after you take expenses into consideration (more on expenses later). And let’s say the property’s cost was $40,000. In this situation, your cash on cash return will be 5%.
The second number you need to look at to get the full picture of your ROI is your internal rate of return or IRR. This figure is a mix of both the property’s equity that you build, as well as the property’s cash flow. For instance, let’s say the value of the property we discussed above will increase by a couple of thousand dollars this year. In this scenario, this year’s IRR will be $4,000, or one-tenth of the total you paid to buy the property.
Calculating Your Expenses
When it comes to calculating real estate investment returns, you need to take a variety of expenses into consideration. For instance, if you decide to take out a mortgage on your investment property, you’ll need to factor in the monthly mortgage payment when calculating the investment expenses.
You can arrive at an estimated mortgage payment for a target property if you know what amount you want to borrow and what the interest rate may be. Also, you’ll need to know the loan term and whether you’re taking out an interest-only loan.
In addition, you need to factor in expenses such as property taxes, maintenance costs, utilities, property manager expenses, homeowners association dues, and insurance costs. The current owner of a property that you’re interested in buying may be able to provide you with much of this information.
Calculate Your Real Estate Returns with Confidence
Need guidance with calculating real estate investment returns? Through my Best Ever Book, as well as my blogs and podcast, you can master how to calculate your real estate ROI and even how to increase your return on investment. Gain actionable advice you can use to succeed this year.
Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.