Return on Investment Calculation

 Understanding how to calculate  returns on your real estate investment can be instrumental to ensure that you make the best use of your resources. To understand the basics use the following guidelines:

The standard of measurement is to use annual net operating income (NOI) on a care-free basis when comparing real estate with other investments. That is, any costs involved in the real estate investment should be accounted for so that the real estate is care-free. The costs of maintenance, management or accounting, etc to manage your real estate must be deducted to arrive at NOI. So even if you are quite capable and enjoy performing the maintenance or renting of your investment real estate, you must allocate an equivalent cost for someone to perform these tasks to arrive at a net operating income. Other costs that you will want to ensure are captured will be taxes, insurance, utilities, vacancy allowance, advertising, licensing and supplies. Then when you have arrived at your true annual NOI you can calculate the simple return or “cap rate”. To do this, take the annual NOI and divide this number by the value of the property.

Return on Investment Calculation

Frequently you will see income and expense statements that do not include "vacancy & bad debt", "maintenance", or "management" costs. Here is a simple and effective way to ensure accuracy.

Start with G.O.I. "Gross Operating Income"

Less Vacancy and Bad Debts (calculate 2% - 4%)

Equals "Effective Gross Income" (you now have the true income & a starting point)

Next deduct expenses. For those missing expenses plan approximately:

  • Management = 4% to 8% (The 4% manager may be the most expensive!)
  • Maintenance = 2% to 5% (dependent on age and condition of property)

Deduct all other expenses to arrive at the N.O.I. or "Net Operating Income".

Deduct A.D.S 'Annual Debt Service" (the mortgage, principal & interest)

Result is "Annual Cash Flow"

To determine your R.O.I. "Return On Investment", divide the cash flow by your investment (down payment + incidentals)

For example if your annual cash flow is $4,000 and you have $50,000 invested, then you are making an 8% return on your money.

In an Agreement of Purchase and Sale (and among many other prudent measures) obtain from the Seller, proof of income statements (copies of leases, etc.) and copies of expenses (utility bills, tax statement, etc.) to ensure the accuracy of your R.O.I.

See an example calculation of cash flow and return on investment on the next page. It assumes a five plex apartment building sold for $600,000 with the Buyer using a $150,000 down payment (25%) to avoid paying a CMHC insurance charge.

Example Of Cash Flow Calculation Income

 

Annual rental income

$70,000

Less vacancy & bad debt (4%)

$2,800

Effective rental

Income

                   $67,200

$67,200

 

Income from parking

$2,600

Income from laundry

$2,100

Total "other" income

                   $4,700

$4,700

Gross operating income (GOI)

                      $71,900

Expenses

Management (6%)

$4,200

Property Tax

$7,000

Insurance

$1,000

Water/Sewer

$800

Heat

$600

Hydro

$600

Maintenance (5%)

$3,500

Total Operating Expenses (TOE)

                 $17,700

$17,700

 

Net Operating Income (GOI -TOE)

                       $54,200

Less Annual Debt Service (Mortgage Of Principal And Interest, Assume $450,000 @ 5% Amortized Over 25 Years)

$27,000

$27,000

Annual Cash Flow

                       $27,200

Return On Investment ($27,200 / $150,000)

                         18%

Sanjin Cvetkovic

Sanjin Cvetkovic

REALTORĀ®
CENTURY 21 In Town Realty
Contact Me

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