Are you looking to invest for high returns? Look no further than flip and fix real estate investments. You can earn significant returns by buying stressed properties and selling them for profit.
However, before jumping into the “flip and fix” world, you must understand how to accurately calculate the return on investment (ROI). In this blog, let’s explore the ins and outs of calculating ROI.
Calculating ROI – Return Of Investment
Here are the 2 methods:
The cost method calculates a property’s return on investment (ROI) by dividing the investment gain by the initial costs.
So, if you get a property worth $100,000 and spend an additional $50,000 on repairs and improvements, resulting in the property’s value being $200,000, your gain in the property would amount to $50,000.
To determine the ROI using the cost method, you would divide the gain by all the costs associated with the purchase, repairs, and rehabilitation of the property, in this case, is $150,000. Therefore, your ROI would be 33%, indicating that for every dollar you invested, you earned a profit of 33 cents.
The Out-of-Pocket Method
Real estate investors often prefer using the out-of-pocket method to calculate their return on investment (ROI) since it typically results in a higher ROI than other methods.
Unlike the cost method, which divides the investment gain by the total costs, the out-of-pocket method divides the home’s current equity by the current market value.
Here’s an example. If you buy a property for $100,000 but finance it with a loan and a $20,000 down payment. You spend an additional $50,000 on repairs.
You have spent $70,000, which is your out-of-pocket expense. Assuming the property’s value is now $200,000, your equity position, or potential profit, would be $130,000.
Using the out-of-pocket method, you would divide the equity position by the property’s market value, resulting in an ROI of 65%.
This is almost double the ROI calculated using the cost method in the previous example. The difference between the two methods is due to leverage, which uses financing to increase the potential ROI.
What Amount Is a Good ROI for Real Estate Investors?
The concept of a “good” return on investment (ROI) in real estate can vary from one investor to another. It depends on their tolerance for risk. Those willing to take on more risk might seek higher ROIs, while more careful investors may be content with lower ROIs in exchange for greater certainty.
However, real estate investors generally aim for returns that are equal, if not higher than, the average returns seen in major stock market indices like the S&P 500. Over time, the S&P 500 has historically delivered an average annual return of around 10%.