Understanding ROI in REI

Posted on: January 31, 2011

Categories: Investors, Profit

Author: lbuen

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ROI Photo Courtesy of thinkpanama on Flickr

REI Doors Open To All

The relative ease of entry is luring more and more people to turn their hands to real estate investing, or REI, not to mention that information about running the lucrative housing business is all over the Internet; you just have to discern which tips and advice to follow. It requires little, some would even say zero, capitalization that is why it is welcoming to beginners. Less capitalization also means lesser risk for losses for the newbies. However, the most enticing lure why people get into REI is the substantial profits that could be raked in in a relatively short time if you get things right.

ROI in REI

One of the most common measures of the quality of an investment is the Return on Investment or ROI. It measures the value of your Net Profit in proportion to the total amount you invested. This measure tells you how much increase you get on your total investment. For example, you bought a house at $100,000 and flipped it for $110,000. In this investment, you get a 10 percent ROI. Note that computing for ROI is not this simple. Remember to factor in all the Expenses you incurred for the property, such as Taxes, Repairs, Marketing Expense and many others.

What if, before selling the house, you rented it out first and you raked in some Rental Income? You also have to add this in computing for your Net Profit. Of course, this is together with the expenses that go along with running a rental property such as Property Management Expenses, Maintenance Expense, Contingency for Vacancy, Insurance, and Real Property Tax. Another item you must not forget to consider is Amortizations.

ROI Versus CCR in REI

What if instead of paying in cash, you used bank financing? This factor can totally tell a different financial story. Going back to the same house in our example, you get a 10 percent increase in your $100,000 total investment. This is the ROI and CCR (cash on cash return) you get since you paid in cash.

What if you only paid a 10 percent downpayment or $10,000? Then your ROI is still 10 percent, but your CCR is now 100 percent. This is the profit you get on the actual cash outlay that you made. The $10,000 actual cash that you invested increased by $10,000.  Obtaining a investment property mortgage when purchasing a rental property is akin to buying stock on margin but supercharged.   For real estate investors, achieving 20%, 30&, or 50% plus cash on cash returns on investment is common place.

ROI and CCR are just two measures that gauge the quality of your investment in real estate, and if you compare these figures with those of other investment vehicles, such as bonds and stocks, you will appreciate REI even more given the leverage available for buying investment property.

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