In 2024, the average real estate return on rental property is 10.6% while the average commercial real estate ROI is 9.5%.
Jump to 5-year historical average real estate returns
Pew Research Center studies indicate that individual real estate investors account for almost 73% of single-unit rental properties in the United States. If you want to be included in this 73% and start earning passive income, understanding your potential return on investment (or ROI) on a property is one of the first steps to getting there.
For a lot of people, real estate investing involves a direct private money loan – or a loan secured by a private company or lender like Revolution Realty Capital. Having the finances to support your real estate investments is critical for earning a positive ROI.
In this post, we’ll explain how to calculate real estate return on investment plus give you common ROI formulas for real estate and the average real estate returns for 2024.
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Real estate return on investment (ROI) is a metric used to calculate profits, and ultimately, measure whether a property is worth investing in. ROI is determined by a number of factors – including purchase price, closing costs, sales price, and more. This metric helps investors predict the profit margins on real estate investment opportunities, be it from 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. However, buying investment property shouldn’t be taken lightly. 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?
Generally speaking, to calculate return on real estate investment, you’ll want to divide your equity in an investment property by the costs associated with it. There are two common return on investment formulas for real estate: the cost method and the out-of-pocket method.
After you understand how to calculate real estate return on investment, it’s crucial that you use the same calculation methods for each property. This will give you a more accurate depiction of which investment property will be most profitable.
For cash transactions (i.e. there’s no lender or financing involved), you’ll use the cost method to calculate ROI either before or after buying investment property. The cost method formula calculates real estate return on investment by dividing a property’s equity by its total costs.
Cost Method Formula: Property’s Equity / Total Costs = ROI
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 $250,000. This means the real estate investor’s equity position in the property is $50,000 (property value of $250,000 less the $200,000 invested in the property).
Let’s apply this equity position in the cost method real estate ROI formula:
Cost Method: $50,000 / $200,000 = 0.25 or 25% ROI
While the cost method is a sufficient ROI formula in real estate for cash transactions, the out-of-pocket method leverages loans and financing. This then increases equity and therefore ROI, and is generally preferred by real estate investors.
Using the same example above, let’s say an investment property was bought for the same price of $125,000. However, the investor opted to finance the property with a loan and made a down payment of only $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 $250,000, the equity position would now be $145,000.
Let’s apply this equity position in the out-of-pocket real estate ROI formula:
Out-of-pocket Method: $145,000 / $250,000 = 0.58 or 58% ROI
Because financing often results in a higher ROI, many investors pursue this route. However, the lender you choose to partner with can also make a positive or negative impact on your returns. With closing periods 10 days or less and some of the most competitive rates in the industry, partnering with Revolution Realty Capital can help you maximize your ROI.