How To Calculate Real Estate Return on Investment + 2022 Averages

Pew Research Center research indicates that individual real estate investors account for almost 73% of single-unit rental properties in the United States. So, how can you get involved and start earning an incredible real estate return on investment (ROI)? 

For a lot of people, real estate investing involves a direct private money loan, which is a loan secured by a private company or lender – like us. Having the finances to support your real estate investments is critical for earning a good ROI. For real estate investors, a “good” ROI is typically around 10%, but an even better ROI is having the funds to invest in multiple properties. 

In this post, we’ll explain how to calculate your real estate return on investment plus averages in 2022.

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Key Takeaways

  • A "good" real estate return on investment is 10% or more.
  • The national average rental property return is 10.6%.
  • The S&P 500 Real Estate Index measures the national average real estate ROI for investments in the GICS sector.
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Daniel William

Co-Foundet Acme Corp

What Is ROI in Real Estate?

Return on investment (ROI) is a metric used to calculate profits, and ultimately, measure whether a real estate property is worth investing in. ROI is determined by a  number of factors, including purchase price, closing costs, sales price, and more. ROI helps real estate investors predict the profit margin expected when flipping or renting out properties. 

The real estate return on investment is typically the reason people get involved in real estate in the first place. It’s important for investors of all experience levels to calculate the ROI for a concrete, birds-eye-view of the profitability of a prospective property. 

So, what is ROI in real estate in your area and how can you calculate it?

Real Estate ROI Formula

ROI is calculated by dividing equity by costs. There are two common return on investment formulas for real estate: the cost method and the out-of-pocket method. 

The cost method formula calculates real estate return on investment by dividing a property’s equity by its total costs. The out-of-pocket method leverages loans to increase equity and therefore ROI, and is generally preferred by real estate investors. 

Let’s say a property was purchased for $125,000. After investing in repairs for a total of $75,000, the property is now valued at $300,000. This means the real estate investor’s equity position in the property is $100,000. 

Let’s apply this equity position in the cost method real estate ROI formula:

Cost Method: $100,000 / $200,000 = 0.50 or 50% ROI

Using the same example above, let’s say the investment property was bought for the same price of $125,000, but financed with a loan and a down payment of $30,000. This makes the out-of-pocket expense only $30,000 plus $75,000 in repairs, totaling $105,000. If the property value remains at $300,000, the equity position would now be $195,000. 

Let’s apply this equity position in the out-of-pocket real estate ROI formula:

Out-of-pocket Method: $195,000 / $300,000 = 0.65 or 65% ROI

How To Calculate Property Investment Return

Property investment return is calculated by multiplying profit by the time, minus operating expenses, divided by the property value. 

Knowing how to calculate property investment return is great for investors who are looking to purchase commercial properties or rental properties. This calculation differs from the ROI calculation in consideration of maintenance costs. Operating expenses, mortgage payments, and rental income are all things to consider when investing in long-term property.

For example, a commercial investment property is worth $750,000. It earns $10,000 in monthly income and the annual upkeep expenses are around $5,000. 

Property Investment Return: [($10,000 x 12 months - $5,000) / $750,000] x 100%  = 15.33% ROI

A rental property is worth $500,000 and earns $5,000 in monthly rent and costs around $2,000 to manage annually. 

Property Investment Return: [($5,000 x 12 months - $2,000) / $500,000] x 100%  = 11.6% ROI

It’s important to note that ROI doesn’t necessarily equal profit. Repair and maintenance costs, amount of money borrowed (including interest, and deals closed below the asking price can all affect ROI and dip into your profit margin. Also, before ROI turns to cash, a property must be sold. 

Average Return on Real Estate

The average annual return over the past two decades from residential and commercial real estate is approximately 10%.​​ The Standard & Poor’s (S&P) 500 Real Estate Index measures national average real estate return on investment, and includes a number of real estate investments like single-family homes, apartments, and commercial buildings – to name a few. 

The real estate return on investment depends on the kind of property being purchased. See the difference between the average rental property return against the average commercial property return below:

Average rental property return: 10.6%

Average commercial real estate ROI: 9.5%

Many investors aim to match or exceed these average return rates. 

Real Estate vs. Stocks Historical Returns

Investing in real estate doesn’t necessarily mean purchasing a physical property. Real estate investment trusts (REIDs) that trade like stocks can provide investors with a diversified portfolio. The chart below compares real estate vs. stocks historical returns via the Vanguard’s Real Estate ETF and SPDR® S&P 500 ETF Trust

  Historical Real Estate Returns Historical Stock Returns
2021 28.59%

40.38%

2020 18.25%

-4.72%

2019 31.29%

28.91%

2018 -4.45%

-5.95%

2017 21.69%

4.95%

2016 11.80%

8.53%

 

Real estate vs. stocks returns is the million-dollar debate that investors are consistently mulling over. 

What Is Cash on Cash Return?

Cash on cash returns (CoC) accounts for the total amount of invested cash into the real estate return on investment formula. In relation to the standard ROI formula mentioned above, CoC returns replace expenses and rental income with annual pre-tax cash flow. 

A $500,000 single-family home was purchased with $200,000 of invested cash and generates $50,000 in pre-tax cash flow each year.

Cash on Cash Return: ($50,000 / $500,000) x 100% = 10% ROI

What Is Cap Rate?

Cap rate, or capitalization rate, is the third most popular way to determine real estate return on investment. Cap rate works to estimate rental property profitability in total, regardless of the financing method being utilized. When comparing properties as an investor, it’s common to use cap rate for a straightforward glance at ROI. 

An investor is looking to purchase a single-family home to rent out and it’s valued at $300,000 with a net operating income (NOI) of $30,000.

Cap Rate: ($30,000 / $300,000) x 100% = 10% ROI

Determining the real estate return on investment is no simple feat. There are many factors involved in becoming a successful investor in the real estate market. We can help.

Apply for a loan today and tell us about your next project.

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