This is a most important question. Today, there are many ways to calculate the return on investing in real estate, but the correct way to compare different investment opportunities is to present the data using the same baseline for the calculation.
When you invest your money, you expect that at the end of the period you will receive more than the amount of money that you originally invested. Any addition to this amount is your return, and by dividing this sum by the period of the investment, it will give you the annual return.
To calculate the return on real estate investment, you must consider its value at the end of the investment period. For example, if you purchased a house for US$100,000, the total rent received over the period should be considered as part of the income. To this is added the difference between the sale and purchase price, and from this equation the purchase costs, maintenance and management expenses must be offset.
The total net profit should be then divided by the period of the investment to calculate the annual return. This can be expressed using the calculation shown below.
Net monthly rental x 12 months x ownership period, divided by the cost of the property.
Here is an example, with all amounts in US dollars
You purchased a property for $100,000.
The purchase costs were an additional $5,000 (attorney, fees, stamp duty, etc.).
Your total investment is $105,000.
Annual rental income is $16,800 ($1,400 per month).
Additional costs include property management (by a professional company), maintenance fund for repairs, and city taxes, totaling $8,400 ($700 per month).
Subtracting the additional costs from the annual rental income results in a net income of $8,400 per year.
After five years, providing the property is sold for $135,000 (in line with average projected price increases over the past five years), your capital profit from the sale will be $30,000 (calculated by the difference between the sale price and the purchase costs).
To this, you add the net current return, which over five years is $42,000. This gives you a total profit over those five years of $72,000. Dividing this amount by five years gives an annual profit of $14,400, representing an annual return of 13.71%, or a 68.5% return over the whole cycle of the investment.
Or using the following calculation: Net income from monthly rent (700) multiplied by 12 months (=8,400), times the number of years.
The number of years the property is owned (5), divided by the cost of the investment (105,000) = 13.71% per annum or 68.5% return over the whole cycle of the investment.
