What's the Return on Investment for Your Property?
Have you ever wondered what the math is behind your Residential Income Property investment?
Your ROI (return on investment) comes from two main places:
1. Regular income from rent or other income ie Laundry
2. Appreciation of the real estate over time.
Now, this is somewhat simplistic but let’s say you buy a rental property for $1,000,000 in cash. Your annual net operating income (NOI) after expenses is $40,000. You hold the property for 10 years. For the sake of simplicity, let’s say your NOI stays the same that whole time and you sell the property for $2,000,000.
Not only have you made an 4% annual return on your property investment, but you’ve also made a $1,000,000 profit. That's a total of $1,400,000 in profit over 10 years (before taxes)
Say lets say you want to make an offer on an income-producing apartment building with an NOI of $100,000 per year. You know from recent commercial appraisals and market research that the average capitalization rate of comparable sold properties in the neighborhood is 4%. That makes the market value of the building about $2,500,000 (divide $100,000 by .04 to arrive at this number).
If you paid for the building in cash, you would earn 4% on your money each year with income from rents. If you buy the property for $2,000,000, you’d be purchasing at a 5% cap rate instead of the average 4% cap rate. That would be a steal as that's a below-market price based on the building's NOI for the neighborhood.
Now, obviously, your Cap Rate Return doesn't account for Debt Servicing (Mortgage, Financing, Loans etc) and so the Cap Rate is just one way of measuring value. There is also the simple Gross Rent Multiplier method (GRM) and then there is the more comprehensive Cash on Cash return, which is the return on the invested capital in which you calculate the cashflow from the profits after paying the operating expenses and debt servicing.
Whichever way you slice it and dice it, your returns in real Estate will ultimately be determined by good decision making, consistent investment principals, clear and measurable goals and a comprehensive exit strategy or long term hold plan. If you need assistance laying out your Real Estate Investment roadmap, contact me and I can help.