Definition of "Return on investment (ROI)"
In order to define the rate of return on investment, or more commonly known as ROI we are also going to explain how it can be calculated and what to look for in the return rate. Investing in property can sometimes be a gamble but if you understand what is the rate of return(ROI), how to calculate it and what is a good rate of return, then your investment should be in good hands.
The definition of return on investment (ROI) examines the profit that investment can bring in percentage from the initial expenses from that investment. A calculated ROI can be related to stocks, real estate, savings accounts or bonds. It helps investors in making better assessments of the potential profit of an investment and whether it is a good investment or not.
The Formula for ROI
In order to calculate the ROI of an investment you take the total return of the investment and divide it from the original cost of investment. You will get a value that represents the percentage of that profit so you multiply it by 100 and add the %.
ROI = ( return on investment / cost of investment ) x 100
ROI = 0.0XX%
There are 4 easy steps to calculate ROI:
- Add up your purchasing investment to any additional costs of the purchase and other investments in the property (remodeling, renovations).
- Separately add up your annual income from your rental property.
- From the annual income you take out the annual expenses (property taxes, insurance, monthly expenses) and that gives you the annual return.
- Divide your annual return by the total initial investment and you’ll get the ROI represented in percentage.
Example of how to calculate the ROI:
- You buy a $200,000 house, and assume the closing costs for the real estate agency would be at about $2,000, remodeling at $18,000. Adding this up we get an initial investment of $220,000.
- The monthly rent for the property is $2,000 and from 12 months you get $24,000.
- From the annual income you take out the monthly expenses of $400/month and get an annual return of $19,200 ($24,000-$4,800)
- Now you divide $19,200 by $220,000 and get 0.087 or 8.7%. This is your ROI.
Or:
- $200,000 + $2,000 + $18,000 = $220,000 (cost of investment)
- $2,000 x 12 (months) = $24,000
- $24,000 - ( $400 x 12 (months)) = $19,200 (annual return)
- $19,200 / $220,000 = 0,087 or 8,7%
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