Learn Real Estate Flip: How to Calculate ROI

Real Estate Flip: How to Calculate ROI

ROI, or Return on Investment, is a way of measuring how much money you will make from an real estate investment such as a house flip.

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What Is Return On Investment (ROI) In Real Estate?

Whether you’re buying a single-family home or apartment building, return on investment (ROI) is an important metric in real estate investing. ROI helps investors determine whether they’ll be able to make enough money on their investment to cover all their expenses, including taxes and mortgage payments.

It is important to know your ROI when you are buying a house or apartment, because it will help you figure out if the house is a good investment. You can compare different properties by their ROI to see which one is a better investment.

Importance Of ROI For Rental Property Investors

When it comes to making money flipping homes in the real estate market, calculating return on investment (ROI) is everything. And there are a few key things you need to keep in mind to make sure you're getting the most bang for your buck.

First and foremost, you need to know what your goal is for the property. Are you flipping houses? Looking to generate monthly cash flow? Or, are you aiming for long-term capital appreciation? These two goals require different strategies, so it's important to have a clear idea of what you want before moving forward.

You don't even need an ROI calculator. Once you know your goal, it's time to start crunching the numbers.

How Is ROI Calculated For A Real Estate Investment?

To learn how to calculate ROI, first determine the cost of the investment. The cost of the investment is the total amount of money that has been put into the property. This includes the purchase price, any repairs or renovations, and holding costs (such as interest on a loan used to finance the purchase).

Next, calculate the income generated from the property. Take the sale price of the property and subtract any selling expenses (such as real estate commissions).

Once both the cost of the property investment and income from the sale have been determined, ROI can be calculated by taking the income from the sale and dividing it by the cost of investment.

Simple Return On Investment Formula

ROI = (Net Income / Cost of Investment) x 100

Net income is your after repair value, minus the cost to flip. This includes costs associated with repairs or renovations, closing costs, carrying costs (property taxes, property insurance, etc.), and financing costs (hard money loan or mortgage on the property). Finally, you'll divide your net income by your total investment.

Keep in mind that the ROI formula only tells part of the story. It doesn't account for factors like timeline or risk. ROI is just one of many real estate investment metrics. It is especially useful when you plan to purchase and rehab the property.

Two Ways to Calculate Your ROI

There are two ways to calculate the return on investment on a real estate flip.

The first way is to take the total value of the property after it has been rehabbed and subtract the purchase price, then divide that number by the purchase price. This will give you your gross profit margin.

The second way is to take your total revenue from the sale of the property (or ARV) and subtract your total costs, then divide that number by your total costs. This will give you your net profit margin.

How Do I Calculate ROI Under Variable Circumstances?

Unfortunately, calculating ROI is not always a simple task. There are many different factors that can affect your bottom line, making it difficult to come up with an accurate number.

For example, putting money into your property improvements, such as repainting the walls and replacing flooring, may yield a higher ROI. The same goes for a rehabber who purchased supplies.

Here are a few tips to help you calculate ROI under variable circumstances:

  • Know all of your costs. Including the purchase price of the property, as well as any repair or renovation costs. Make sure to factor in both direct and indirect costs, such as interest payments on loans and fees paid to contractors.
  • Estimate the future value of the property. Add closing costs to your anticipated selling price. If you are converting the property to a rental, use an estimated monthly rent and multiply it by twelve.
  • If you are selling a property that depreciated in value during the time you owned it, you must also factor the loss of value into your calculations. In other words, subtract the purchase price from the sale price; this is your depreciation.

ROI Calculation Examples For A House Flip

Let's say you are a real estate investor buying a fixer-upper for $100,000 and you want to calculate the ROI. You estimate your costs to be $30,000 in rehab expenses and another $5,000 on selling expenses. You then sell the property for $200,000. The return on your investment would be: (($200,000 - $100,000 - $30,000 - $5,000) / $100,000) x 100 = 65%.

What Is An Average ROI On Real Estate?

An average ROI, on a real estate fix and flip project has traditionally been between 50 and 100 percent. Of course, flipping a house won't always offer such a high return.

Expected ROI from house flipping can fluctuate based on the current economy too. In 2017, average expected ROI was 51%. It then dropped dropped to 31% in 2021 (source). There are many reasons for this drop. Increased competition to buy houses pushed purchase prices through the roof, and supply issues drove up the rehab costs. In a stable buyers market with fewer supply chain issues, we might expect a higher investment return.

Cap Rate vs ROI : What’s the Difference In Real Estate Investing?

There are a number of ways to measure the profitability of a residential real estate investment, but two of the most common are return on investment and capitalization rate (cap rate). While both measures can be helpful in evaluating investment properties, they each have their own strengths and weaknesses.

ROI is useful in comparing different investments, but it doesn’t take into account the time value of money. For example, if two properties have an identical rate of return, but one takes six months to generate that return while the other takes two years, the shorter-term investment is probably a better choice.

Cap rate, on the other hand, is the ratio of net operating income to property value. It is expressed as a percentage. The higher the cap rate, the more an investor can expect to earn on his or her investment. Cap rate is used by investors when analyzing and comparing a similar type of investment.

For illustration, say you expect to purchase a rental house for $150,000. The rental income is $24,000 per year, with $12,000 in operating expenses. NOI, is $12,000 ($24,000 - $12,000). Your Cap Rate would be 8% ($12,000/$150,000 = 0.08).

Depending on the type of investment, you may be willing to accept a lower cap rate for one investment than for another. Purchasing a property with a lower cap rate might make sense if the purchase price is considerably less than others. But, generally, when investing in real estate, investors aim for returns that match or exceed their expected cap rate for that type of class in that specific market.

Classes are expressed as A through D. Where Class A is the highest quality property in the market, and D is the lowest. Class A properties will generally be newer buildings, or newly remodeled (think old factory converted to hip and cool new apartment complex) in the most desirable part of town. Class D will typically be run-down (but live-able) building in an undesirable section of town.

You would expect a much higher profit and return on the Class D property. However, along with that higher average monthly profit will come more headaches - lower quality tenants and more repairs. This might not be universally true, but close to it. You will have to determine how much profit is worth the headache.

The cap rate might be higher in a rural area than a nearby city. Does that make the rural property a better investment? Maybe. However, you need to consider how the difficulty in managing that property. Out in the country it may be more difficult to find an experienced property manager, or coordinate repairs if you decide to manage the property yourself.

Return on investment more useful metric when flipping a property, while Cap Rate will be more useful to the rental property investor.

Cash-on-cash return vs Return on Investment

When flipping a house, cash-on-cash return (CCR) is one of the most important metrics to consider. CCR is simply the percentage of pre-tax cash flow that's left after all expenses are paid. Return on investment, on the other hand, is a bit more complicated. It takes into account the time value of money and is therefore a more accurate measure of profitability.

ROI Is Not the Same as Total Profit

It's important to remember that potential ROI is not the same as profit from a flip. ROI is a measure of how much money you make on an investment, while profit is the leftover money after you've paid all your expenses.

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