Calculating the Return on Investment using the

4 benefits of Real Estate Investment

There are several calculations to determine the return on investment or ROI for an investment property.

One way to determine if an investment is sound is to look at the net operating income (NOI) verses the purchase cost. This is typically called a Capitalization Rate or Cap Rate. Its a calculation that a lot of people in the investment world talk about when discussing the ROI of an investment. However, if really does not use any of the 4 investment benefits already discussed. If you paid all cash for the investment property then CAP rate would be a good measure of valuation. However, in our example, since we have financed the purchase, its not the best calculation.

Cap Rate NOI/Purchase Cost $11,525 ÷ $165,000 = 6.98%

The next calculation, called Cash on Cash. takes into consideration your income benefit or cash flow before taxes (CFBT) verses the cash invested. Since we financed the investment property this is very similar to a dividend yield on a stock. While this calculation is better than the Cap Rate calculation, it still does not take into account the other 3 benefits and, therefore, is not the best calculation either.

Cash on Cash CFBT/Cash Invested $986.60 ÷ $33,000 = 2.99%

An even better calculation for determining your return on investment is, Return on Investment without Appreciation which takes into account 3 of the 4 benefitsIncome, Principal Reduction, and Depreciation. This will tell you how the investment property stacks up to other investments. Remember that in calculating the depreciation benefit you saved $1,092.88 in taxes (a negative number). This is a good thing and you add it to the other benefits as follows:

ROI without Appreciation CFBT + Principal Reduction + taxes saved/Cash Invested $986.60 + $1,340.88 + $1,092.88 ÷ $33,000 $3420.66 ÷ $33,000 = 10.36%

This is a pretty good Return on Investment! Not many investments can beat this. And remember, this is just one investment property. There will probably be others that make even better sense. This method of analyzing an investment property is pretty good. However, the next one, is going to be the best because it takes into account the 4th benefit Appreciation.

The 4th calculation is the same as above but includes appreciation. Return on Investment with Appreciation is going to be our best method for analyzing an investment property. In our example, you assumed zero appreciation in the first year so the calculation gives you the same answer. Your final worksheet should look like this .

Congratulations on working through the investment property calculator. Now you have a great tool to assist you in your search for the right investment properties. You can use this over and over with each property you look at. Furthermore, its a good idea to perform this calculation every year on the anniversary of your purchase of the property. We will discuss this in greater detail later.