Investing in commercial real estate can be a great way to grow your wealth and diversify your portfolio. But with any type of investing, you want to make sure you understand the risks and rewards associated with it. That’s why understanding how to calculate return on investment (ROI) is essential for any real estate investor. In this blog post, we’ll discuss how to calculate ROI when investing in commercial real estate. We’ll cover the different factors that go into calculating ROI, what types of investments yield the highest returns and tips for finding the best investment opportunities.
What Is ROI In Real Estate Investing?
The term “return on investment” (ROI) refers to the amount of money made after subtracting the initial cost made in order to make an investment. This measurement can be used to analyses an investment’s efficiency and productivity in the big picture, or in relation to others. With the help of this you calculate the return on investment for a commercial building you have recently purchased.
Gain from Investment minus Expenses = Return on Investment
For example, if you invest $100,000 in a commercial real estate property and it generates $5,000 in positive cash flow each year after expenses, your ROI would be 5%. It’s important to remember that ROI is just one metric to consider when assessing a real estate investment. You also need to factor in things like risk, time frame, and liquidity when making your decision.
How Is ROI Calculated for Real Estate Investments?
To calculate the ROI for a real estate investment, you will need to take into account several factors. First, you will need to determine the purchase price of the property and the associated closing costs. Next, you will need to calculate the expected rental income from the property and any possible appreciation in value. Finally, you will need to consider the expected operating expenses for the property, including repairs, maintenance, and property taxes.
Assuming all these things, the higher the purchase price of a property and the associated closing costs, the lower the ROI will be. The same is true for expected rental income and appreciation in value, higher values result in a lower ROI. Operating expenses also play a role in calculated ROI since they reduce overall profitability.
The Cost Method
The cost method is the most common method used to calculate commercial real estate investment returns. The cost method is simply the difference between the purchase price and the sale price, divided by the purchase price. For example, if you purchase a property for $1 million and sell it for $1.5 million, your return would be 50%. If you held the property for five years and sold it for $2 million, your return would be 100%. The cost method does not take into account any expenses incurred during ownership, such as mortgage interest, property taxes, insurance, or repairs and maintenance. Therefore, this method will usually understate your actual return on investment.
Read Also: Best Cities for Commercial Real Estate Investment
The Out-of-Pocket Method
The out-of-pocket method is one way to calculate your commercial real estate investment returns. To use this method, you’ll need to know your total investment, including any acquisition costs, and your expected cash flow from the property. Your return on investment (ROI) is calculated by dividing your net operating income (NOI) by your total investment. Your NOI is your expected cash flow from the property minus any operating expenses. For example, let’s say you’re considering an office building that will cost $1 million to acquire. You expect the property will generate $200,000 in annual cash flow after operating expenses are deducted. In this case, your ROI would be 20%. It’s important to remember that ROI is just one way to measure the performance of a potential investment. It doesn’t take into account the time value of money or other factors such as risk. But it can be a helpful tool for comparing different investment opportunities.
What’s a Good ROI for Commercial Real Estate?
For commercial real estate investing, there is no single number that is considered a “good” ROI. For any commercial real estate property, figuring out what a “good” ROI is depends on a lot of different factors, each of which comes with its own set of challenges. In some scenarios, what one commercial real estate investor thinks is a “good” return on investment (ROI) may not be the same as what another investor thinks are a “good” ROI. Also, a good return on commercial real estate investments depends on how risky the investor is willing to be. As a general rule, the more risk you’re willing to take, the higher your return on investment (ROI) should be. So, a return on investment (ROI) of 10% or more can be considered as “good.”
