Investing in real estate is an excellent, long-term investment, but it requires excellent management and realistic expectations. You cannot afford to guess how much money you will make from a property. Instead, you need to determine potential and actual ROI.
All real estate investors are looking for a solid and sustainable return on their commercial real estate investments. But you may be confused about what an acceptable ROI is. For instance, a good ROI for rental property is generally above 10%, but anywhere from 5% to 10% may work for you, depending on the level of risk you assume and your own financial expectations.
When it comes to the ROI commercial real estate investments can produce, you must consider the cost of upkeep, the property’s appeal to business owners, and your cash flow needs. The calculations may sound difficult, but the formulas for determining profitability are really pretty simple.
What Is ROI?
Return on investment, or ROI, is a calculation used to determine if an investment is performing as it should. By using a simple mathematical formula, you produce a percentage that serves as a success yardstick of sorts. It allows you to compare the return from your various investments and consider if they are worth maintaining. ROI is a tool that is used by most industries.
How Do You Calculate ROI?
To determine ROI, you first subtract the cost of the investment from the total ROI to determine your net gain. For instance, if you bought stock for $10,000 five years ago and sold it today for $15,000, your net profit or net gain would be $5,000. You would then divide this number by the original cost to get your ROI percentage: $5,000/$10,000, which equals .50 or 50% ROI. Of course, a 50% ROI is quite high and not the usual return for many investments, including real estate.
How Do You Calculate ROI for Real Estate?
Calculating ROI for many investments, including real estate is a bit more complicated than the above example because you have to consider multiple expenses and your initial investment.
Figures You Need to Determine Rental Property ROI
According to Forbes, you need to have the following information on hand to determine rental property ROI.
- Property Details: This category includes property repair costs, number of bedrooms, square footage, etc.
- Mortgage Terms: These include the down payment, closing costs, length of the loan, and interest rate.
- Rental Income: You will need to calculate what your monthly rental income will be and the vacancy rate percentage.
- Monthly Rental Expense: These expenses include monthly repairs, general maintenance fees, monthly utilities, monthly dues (if applicable), and any property management costs.
- Annual Costs: These costs include property taxes and property insurance premiums.
You can use these figures to project ROI on a property you are considering buying or on the one you already own. Certainly, you want to have a good idea of what ROI you can expect before buying.
Calculating Rental Property ROI
Once you have this information, you can calculate your basic ROI. But you will need to do some further calculations before determining exactly how well your investment is doing. These calculations include:
- Net Operating Income (NOI): You can calculate this number by subtracting all operating expenses for the property from the gross income generated by the property.
- Capitalization Rate (Cap Rate): You determine the cap rate by dividing your NOI by the price of the property. The NOI helps you compare all of your real estate investments.
- Cash-On-Cash Return: You use this figure to learn what return you should expect from your real estate investment. Simply divide your after-tax annual cash flow by the purchase price of the property.
- Annual Gross Rent Multiplier: Also known as the GRM, it helps you measure the value of your investment. To get this figure, divide the sales price by the annual gross rent.
- Annual Cash Flow: You calculate your annual cash flow by your NOI minus your debt. This figure represents how much you will profit or lose from your rental each year after the expenses and mortgage are paid.
These figures help determine if your real estate investment is bringing in the kind of return that it should.
How Do You Improve ROI Commercial Real Estate Opportunities?
To improve the ROI of a commercial property, experts recommend taking the following steps:
- Regularly Upgrade the Property: High-end and reliable tenants are drawn to properties with modern amenities and excellent overall maintenance. If you want to attract and retain the best tenants, keep your building up-to-date.
- Minimize Costs: Cutting costs can be as simple as analyzing your current expenditures and cutting the fat. However, you cannot compromise the look and efficiency of your property. You may be able to cut costs and maintain quality by turning to technology. You can lower utility costs by employing utility software that monitors and regulates heating and cooling. You can also reduce security costs by using more advanced cameras and alarms and hiring fewer actual guards.
- Multiple Revenue Streams: You may be able to improve your ROI by adding more revenue streams to your property. You may be able to rent garage space, for instance. You might also consider selling certain items that your tenants routinely need, such as locks or mattress covers.
- Hire a Property Manager: Although you will be paying out a set amount each month, good property management companies more than pay for themselves. They promptly take care of maintenance issues, collect rent, and work to fill vacant units. Your ROI will go up as your stress level goes down.
And of course, you should always look for bargain properties — those with a lower price but lots of potential. You’ll pay off your property and see solid profits much faster if you avoid paying top dollar for highly competitive commercial properties.
Finding the Right Commercial Properties
Finding the best ROI commercial real estate opportunities means using multiple resources such as local realtors, mortgage brokers, commercial insurance agents, and online property databases like ProspectNow. When you utilize your local network and online sources, you can identify properties with excellent ROI potential.
The Prospect Now Advantage
Using a property database like ProspectNow is an efficient way to gather information on promising commercial properties. Our database boasts 42 million commercial listings as well as over 100 million residential properties. Prospect now is dedicated to helping real estate agents, brokers, and other professionals find information about properties that will bring in a healthy ROI, both locally and throughout the United States.
You can easily get information about the property owners and the property’s listing status, location, taxable value, and tax liens. And while your personal network is certainly helpful, using our database is faster and more comprehensive. You can do your in-depth research from the comfort of your home.