Friday, February 01, 2008

Calculate Investment Return on Real Estate

If you buy property or real estate, how do you calculate the ROI (Return of Investment)? Is it by your rental income or capital gain? Do you include the ownership fees to purchase your house? How about renovation cost? Lets look at the calculation below how to calculate the ROI by rental income and capital gain. Calculating the ROI for property can help you decide whether you should buy that house or not.

ROI by Rental Income

If you purchase a house for the purpose of rental income, you may want to calculate your ROI based on rental income.

Property Purchase Prize: $180K

Ownership Fees: $2K

Renovation Cost & Furniture: $40K

*Ownership fees are legal fees, government stamp duties, loan agreement fees and etc.

Total Purchase Price = $222K ($180K + $2K + $40K

Maintenance Fees (Monthly): $100

Monthly Rental Income: $800

* Maintenance fees are insurance, security fees, property damages and whatever cost to maintain the house.

Monthly Net Rental Income: $700 ($800 — $100)

ROI = Net Rental Income for Year / Total Purchase Price X 100%

ROI = 3.8% ($700 X 12 / $222K X 100 %)

So, the ROI for income rental gain is 3.8% .

ROI by Capital Gain

Total Purchase Price: $222K (Calculated from above)

Selling Price (in a year): $230K

ROI = ($230K — $222K) / $222K X 100%

ROI = 3.6%

So, the ROI for capital gain is 3.6% .

If you purchase the property for the sake of investment by earning the rental income, the ROI is 3.8%. To be more optimistic, you may also include your capital gain which is 3.6%. So the total ROI for the house that you invest is 7.4% (3.8%+3.6%).

If you purchase the property for staying, you can only calculate the ROI based on the capital gain. In this case, your ROI is 3.6%. Please note that youre now enjoying the house and at same time youre also enjoying the capital appreciation at 3.6%. Isnt this a perfect investment?

My 2 Cents

If I am buying a house for investment by renting out my property, I would look at the property that has at least 7% ROI (exclude the capital gain conservative calculation). Reason is the Fixed Deposit (FD) is 4% and my average investment return from unit trust is 7%. If the ROI is less than 7%, I may as well invest it in unit trust. Remember that the rental income gain or capital gain from property is not the actual gain because we haven’t consider the mortgage interest yet. On the other hand, if I am buying a house for staying, I will also look at the property with at least 7% ROI as well. The reason is same with what I mentioned.

How do you calculate the ROI for your property? What ROI value will make you decide to buy the house? Do you really calculate the ROI when purchase a house? If no, maybe it is time to think about it.