Invest in Real Estate: Your Return on Investment (ROI) – What Does It Include Other Than Cash Flow?

Invest in Real Estate: Your Return on Investment (ROI) – What Does It Include Other Than Cash Flow?

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The easy to use metric called ROI or return on investment has been a popular metric for measuring business performance for quite a while now.

It mainly focuses on cash flow, but there are other things involved. This article will explain all of that, and in turn, enable you to have a better understanding of ROI in the real estate business, where its use is usually considered more complicated than with other industries.

How Is ROI in Real Estate Calculated?

The popularity of ROI stems from its simplicity and the fact that it’s mostly easy to calculate.

ROI is calculated by dividing your net income and the cost of the investment you made. You can also calculate it by subtracting revenues and the costs of your investment and then dividing that number with the costs of your investment once again.

The main thing to know here is that it’s much better to show ROI as a percentage and not a ratio.

Now, the complication in real estate ROI stems from the act that property can be refinanced or a second mortgage can be taken out. That means that either the interest rates might change or loan fees can be charged. Both of these can have a significant effect on ROI. When these new numbers are used in the calculation, the ROI will usually reduce significantly.

Additionally, you also need to take into account the increase in maintenance costs and property taxes.

All of this slightly complicates the calculations you need to make to find the exact return on investment percentage.

What Does ROI Include?

The main thing people confuse when calculating ROI is the cash flow. Most believe that ROI only includes cash flow, but the reality is very different.

Yes, it is true that ROI can include cash flow, but you cannot obtain the exact ROI unless profit is involved.

When ROI only includes cash flow, the numbers remain incomplete. To achieve the right calculation, one must take into account the profit the investment made, as profit is always different to cash flow.

Additionally, the remaining important part of ROI should always be the minimum return. It is often called the hurdle rate, and it’s up to you to determine which number is what you need. All the finances involved need to be calculated to determine what the minimum return should be for you specifically. From that, you will know that anything above it, will be a positive result.

By making proper calculations, you will be able to gain a good picture of how your investment is performing and whether or not it’s bringing in enough money.

Calculating the exact ROI is essential, as a slight change in the result can show something entirely different and might warrant abandoning the investment for no real reason but a poor ROI calculation.

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