When you look for ways to put your money to work, real estate may catch your eye as a source of potentially big profits. Whether you buy a home to live in or purchase undeveloped land, calculate your return on investment. ROI can include rents paid by tenants on houses, duplexes, apartment buildings and office buildings. ROI also encompasses appreciation in the value of property, including a home, commercial buildings and unimproved land.
ROI with Leverage
If you put $20,000 down on a property worth $140,000, your investment is $20,000. Don’t make the mistake of counting the full amount as the value as your investment. Real estate investment allows you to leverage your money. That is, you control a much larger value by putting down a smaller percentage on the purchase. When you pay a down payment on a home, land or commercial real estate, you receive all of the ROI from that property. A comparable investment in stocks, for example, might produce a return of 15 percent. For a $20,000 investment, 15 percent is $3,000. If your property worth $140,000 appreciates 15 percent, the increase in value is $21,000. Calculate your ROI by dividing your gain by your investment and multiply by 100. In this case, 21,000 divided by 20,000 times 100 shows that your leveraged investment produced a 105 percent ROI.
ROI Using Capital Gains
Capital gains come from an increase in the property value. Even if you don’t sell a property, you can estimate its current value vs. the original value. Use comparable properties in the local area for your estimate. If you prefer, you can hire a professional appraiser. Capital gains apply to any type of real estate, including a home, unimproved land or buildings you rent to tenants. To calculate ROI using capital gains, determine how much the property has appreciated in value. For example, if you invested $20,000 in a property and it went up $10,000 in value, divide 10,000 by 20,000 and multiply by 100 and you find you made a 50 percent ROI.
If you invest in a property that is leveraged (you make a down payment but get all the capital gains from the full value), produces income and incurs expenses, you need to combine all of your factors into one formula: ROI equals capital gains plus income, minus expenses, divided by your investment. For example, if you had $10,000 in capital gains plus $5,000 in income, that totals $15,000. Subtract expenses of $2,500 and your net figure is 12,500. Divide that by an original investment figure of $20,000 and multiply by 100, and you find that you made 62.5 percent ROI in this example!