How to calculate the ROI of a real estate investment
Real estate investing is an excellent way to generate wealth, but it’s important to know how to calculate the ROI of a real estate investment before investing your money. ROI is a ratio that measures the profitability of an investment by comparing the return on investment to the cost of the investment. Return on investment (ROI) is an essential metric for real estate investors because it helps them evaluate the potential profitability of an investment and make informed decisions about whether or not to invest in a particular property.
In this blog post, we will outline the steps on how to calculate the ROI of a real estate investment using the Nigerian Naira currency. Before we delve in, let’s give you a quick outline. Feel free to click any of the topics below to be taken directly to the section:
Steps to Calculate the ROI of a real estate investment
To calculate the ROI of a real estate investment, there are five essential steps that need to be taken. These steps are:
- Determine your Investment Costs
- Calculate your Rental Income
- Estimate your Expenses
- Determine your Net Operating Income
- Calculate your ROI
1. Determining Your Investment Costs
Investment costs in real estate include the purchase price of the property, closing costs, and any renovation or repair costs. When investing in real estate, it’s essential to consider all the costs associated with the investment to determine your total investment costs accurately. The following are some of the costs associated with investing in real estate:
- Purchase Price: This is the amount of money you pay to acquire the property.
- Closing Costs: These are the expenses associated with closing the sale of the property, such as legal fees, agency fees, and other taxes.
- Renovation and Repair Costs: These are the expenses associated with fixing up the property to make it rentable, such as painting, plumbing, electrical work, new appliances etc.
To calculate your total investment costs, add the purchase price, closing costs, and renovation costs. For example, if the purchase price of a property is 10,000,000 Naira, and the closing and renovation costs amount to 1,500,000 Naira, the total investment cost will be 11,500,000 Naira.
2. Calculating Your Rental Income
Rental income is the amount of money you receive from renting out your property. The rental income depends on several factors, such as the location, the size of the property, and the current rental rates in the area. To calculate your rental income, you need to know the monthly rental rate and the number of months the property will be rented out each year. The rental income can be calculated using the following formula:
“Rental Income = Monthly Rent x number of months in the year”
For example, if the monthly rental rate is 100,000 Naira, and the property is rented out for ten months in a year, the total rental income will be 1,000,000 Naira (100,000 x 10).
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3. Estimating Your Expenses
Owning and operating a rental property comes with several expenses that you need to consider when calculating your ROI. These expenses include property taxes, insurance, maintenance and repair costs, property management fees, and utilities. To estimate your total expenses, you must add up all these costs for a year.
For example, if the property tax is 500,000 Naira per year, insurance costs 100,000 Naira per year, maintenance and repair costs are 200,000 Naira per year, and property management fees are 150,000 Naira per year, and utilities cost 50,000 Naira per year, the total expenses will be 1,000,000 Naira.
4. Determining Your Net Operating Income
Net operating income (NOI) is the income generated by the property after deducting all the operating expenses. NOI is an important metric for real estate investors because it reflects the true profitability of the investment. To calculate NOI, subtract the total expenses from the total rental income. The formula for NOI is as follows:
“NOI = Rental Income – Total Expenses”
For example, if the total rental income is 1,000,000 Naira, and the total expenses are 1,000,000 Naira, the NOI will be 0 Naira. If the total rental income is 1,500,000 Naira, and the total expenses are 1,000,000 Naira, the NOI will be 500,000 Naira (1,500,000 – 1,000,000).
5. Calculating Your ROI
After determining the total investment costs, rental income, expenses, and NOI, it’s time to calculate the ROI. To calculate the ROI, divide the NOI by the total investment costs and multiply by 100 to get a percentage.
The formula for calculating ROI is as follows:
“ROI = (NOI / Total Investment Costs) x 100%”
For example, if the total investment cost is 11,500,000 Naira, and the NOI is 1,500,000 Naira, the ROI will be:
ROI = (1,500,000 / 11,500,000) x 100% = 13.04%
This means that the ROI for this particular real estate investment is 13.04%.
Conclusion on how to calculate the ROI of a real estate investment
In conclusion, calculating the ROI is crucial for real estate investors because it helps them evaluate the potential profitability of an investment. To calculate the ROI, you must determine the total investment costs, rental income, expenses, and NOI. Once you have this information, you can use the formula to calculate the ROI. By following these steps, you can decide which properties to invest in and how much to invest.
So, I encourage you to calculate the ROI of a real estate investment yourself, using the knowledge you have gained from this post. Take the example of the STOW fractional home investment plan and see what kind of returns you could expect. Who knows, it may just be the start of a successful real estate investment career.