Understanding how to calculate ROI can elevate an investor’s understanding and ability to assess opportunities.
Think of Return on Investment (ROI) as the linchpin of property investing. It lets you gauge the financial fruitfulness of your ventures and paves the way for smarter decisions regarding current and new investments.
But how do you calculate the ROI as a property investor? That’s the purpose of this guide, which has everything you need to know about calculating the return on your investment for better decision-making.
What is ROI? Property Investment ROI explained
Return on investment quantifies the return of any investment against its cost. Within property investment, it’s a lens to scrutinise rental property profitability or the projected returns on a property flip.
So what is the calculation for those seeking ‘how to calculate ROI’? To get the ROI, an investor needs to determine the annual rental income of the property (if it’s a buy-to-let), minus the expenses tied to it. The resulting figure is then divided by the cash invested into the property, with the result expressed as a percentage. The figure you’re left with is the ROI.
For a property flip, you need to calculate the investment costs, such as purchase price and renovation, with the sale price.
How to calculate ROI?
Before you can calculate the ROI, you’ll need to know the net income and the total amount invested.
What is net income?
Net income is the amount generated by the investment minus the expenses. For example, if your rental property earns £20,000 a year in rental income, but your expenses are £5,000, the net income is £15,000.
What is the total amount invested?
The total amount invested is how much you paid for the property plus any subsequent investments. This could include money spent on improving the property, such as putting in a new bathroom or kitchen.
There are two primary ways to calculate the ROI: by using a calculator or a spreadsheet. Most people will use an online calculator, but some may prefer to do their own calculations via a spreadsheet.
How to calculate ROI – The Formula:
ROI = (net income divided by total investment) x 100
The result is expressed as a percentage, with a positive ROI indicating the investment is profitable. A negative ROI, on the other hand, suggests a loss. Generally speaking, the higher the ROI, the more profitable the investment.
Why ROI is Important for property investors
Investing in bricks and mortar involves a significant outlay. And while there are no guarantees, you want to give yourself the best chance of making a profitable investment. This is the reason so many seek answers to the question, ‘how to calculate ROI’. Being able to calculate the ROI gives you a clearer indication of whether the investment is profitable or not.
The long-term goal is profitability if you’re investing in a property, whether it’s buy-to-let, flipping or even land development.
Having ROI to hand helps you make a better decision about a variety of aspects, such as whether you should buy, sell or hold onto a property.
What about financing?
The ROI also helps when it comes to decisions regarding financing. Lenders have strict lending policies and want to see that the borrower can comfortably make the monthly loan repayments.
For lenders it’s all about determining the risk, and a strong ROI typically means the lender isn’t taking on a significant gamble.
What is the rental yield?
If you’re renting out the property, you’ll want to know about rental yield as well as ROI. The two are intrinsically linked, but the rental yield is used by investors to evaluate how much the property might generate in income compared to the outlay.
It’s calculated the same as ROI, taking the annual rental income, dividing it by the property value, and then multiplying by 100 to get a percentage. This percentage gives an investor a quick glimpse at the property’s potential to generate income relative to its cost.
Assume a property is bought for £200,000.
The monthly rent collected is £1,000.
Annual rental income would be £12,000 (£1,000 x 12 months)
Now, to calculate the rental yield:
Rental yield= £12,000 divided by £200,000 times 100
Rental Yield = 6%
It’s by no means a guarantee of income, but it gives you a decent idea of whether a potential investment may or may not be beneficial. Generally speaking, a good yield is anything over 5%.
How does it differ from ROI?
Rental yield focuses on income from rent relative to property value, offering a snapshot of current income potential. On the other hand, ROI encompasses all financial aspects, including capital appreciation and costs, providing a holistic view of an investment’s performance over time. While rental yield is usually annual, ROI can reflect long-term performance.
How to calculate ROI when investing in property
Return on investment provides clarity when investing in property and aids investors so they can size up profitability.
While no investment is a ‘sure bet’, grasping the ROI will steer you towards smarter investment choices, whether it’s buy-to-let, building a portfolio or property flipping.
To discuss your plans to invest in property with a member of our team, please do get in touch.