ROI is one of several profitability measurements in real estate investing. Other profitability metrics are capitalization rate, internal rate of return (IRR), and cash-on-cash returns. Investors should use several profitability metrics to help determine whether a real estate investment is worthwhile.
How to calculate ROI on real estate
In its simplest form, the formula for calculating ROI in real estate is:
ROI = (Investment Gain - Investment Cost) / Investment Cost
There are two primary methods of calculating ROI using this formula: the cost method and the out-of-pocket method.
Calculating ROI using the cost method
For example, a house flipper buys a property for $500,000 in cash. They spend another $100,000 on repairs and improvements, giving them a total cost of $600,000. Upon completion, they sell the renovated house for $750,000. Here's the ROI for this property using the cost method:
ROI: ($750,000 – $600,000) / $600,000 = 25%
Investors can also use a simple ROI formula to calculate the returns on a rental property. For example, an investor bought a rental property for $500,000 in cash. It generates $35,000 in yearly rental income and has $10,000 in annual costs. Here's the ROI using the cost method:
ROI: ($35,000 - $10,000) / $500,000 = 5%
