When you buy an investment property you do so because, well, it’s an investment. You hope to make money on it and get a return on that investment whether that be in the short or longer-term.
Return on Investment (ROI) is the measure of how much money you make over the life of holding your property. How you realize ROI can vary based on the type of investment property you buy. In some cases, you will have multiple streams of revenue that contribute to your ROI.
How do I determine ROI?
- To figure out your ROI you need to know how much you have spent in the first place. This includes:
- Purchase price/downpayment
- Monthly expenses (anything you cover like insurance or utilities)
- Improvement costs
- Any other fees (like a homeowners association)
Your investment in a property will increase over time but you can realize a return on that investment in two ways. This isn’t an either/or situation and, in many cases your ROI will be determined by both factors.
- How much profit you make renting the property (whether that be monthly, long-term, or on a vacation-style system)
- The amount of profit you make by selling the property for more than you paid for it.
If you buy a house to flip it , for example, you would not have any rental income. Your ROI would be purchase price plus whatever you spend on renovation and in holding costs while you do the work minus the sales price. Hopefully, you can sell it for more than than you spent and you will have a positive ROI.
In the case of a rental property, there are multiple scenarios. Sometimes you may buy a property that barely breaks even on a rental basis because you believe it will appreciate in value and eventually deliver a strong ROI. In other cases, you might be looking to make a steady profit and then sell the property if it hits a certain valuation.
There’s all sorts of degrees in which these scenarios can play out. You might, for example, also use your investment property (maybe you have some space in an office building you own or use a vacation home for two weeks a year). In those cases, there’s some value that’s not strictly numeric. When that happens you will want to factor whatever benefits you get in as sort of non-cash ROI.
Know your numbers
Before you buy any property it’s very important to understand all of the numbers involved. If you plan to rent out your investment property, you need to know what going rates are how much demand exists.
If you’re buying with the idea that the property will go up in value over time so immediate returns aren’t very important, be very careful. There’s no guarantee that any property rises in value or that market conditions will follow past patterns.
Markets slow down. New areas get developed or become hot. Things can change and you don’t want to have made a big investment only to see it lose value or produce below your desired ROI.
Ideally, unless you’re flipping a property (and that’s really best left to experts) you’ll want to own properties where you can make a profit on an ongoing basis and realize another profit when you sell it. That’s a formula for ROI that protects you from falling values as long as you can keep your property rented. It’s also worth noting that positive rental income will help you sell the property for a higher rate as buyers will be calculating their expected ROI as well.
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