Average ROI, or return on investment, serves as a barometer for gauging the profitability of a given asset, be it real estate, stocks, a portfolio of assets, etc. It offers investors a snapshot of how their capital is performing, especially when compared to other investment opportunities. This metric is applicable for residential real estate, commercial real estate, and rental property ventures.
According to Bankrate, The average ROI on residential real estate investment is about 10.6% in 2023. This can vary significantly depending on the factors such as property type, location, market trends, and interest trends. Bankrate also estimates that commercial property returns are slightly lower at about 9.5%, while REITs provide a slightly higher return of 11.8% on average.
Real estate investing offers a vast array of opportunities that attract investors. This may include traditional investment properties like office buildings, residential real estate, or alternative investment options such as real estate syndication deals. As real estate investments evolve and diversify, being well-versed in the intricacies of ROI becomes important. For investors, the challenge usually lies in understanding and effectively applying the information about return on investment.
Common Types of Real Estate Investments
Real Estate Syndication
Real estate syndication is a partnership where investors come together to invest in larger properties or projects. This model allows individual investors to venture into bigger, often more profitable deals that might be beyond their individual capacity. The returns, both cash returns and appreciation, are shared amongst parties based on the initial agreement, mostly commonly referred to as the private placement memorandum, or PPM.
Residential Real Estate
Residential real estate stands as a preferred choice for many entering real estate investments. Investors secure homes, either by buying or building, and rent them out. This rental property serves as a (hopefully) consistent monthly income source. With properties such as long- and short-term single-family rentals, the ROI largely depends on elements like location, demand, and the projected annual rental income.
Commercial Real Estate
Delving into commercial real estate investing involves targeting business-oriented properties, which might range from office buildings to warehouses, or even large scale residential, aka apartment complexes. The primary source of income here stems from long-term lease agreements. Notably, the average capitalization rate, crucial to calculate ROI, often shows higher numbers in commercial real estate compared to residential counterparts.
Industrial Real Estate
Falling under a specialized category of commercial real estate, industrial real estate covers assets like warehouses, factories, and distribution hubs. The two-fold investment returns from such real estate emerge from both rental income and the appreciation of the asset.
Retail Real Estate
Retail real estate constitutes spaces such as shopping centers and standalone retail outlets. Here, the investor’s income is derived from rent, usually from stores or retail businesses. In some cases, the deal sweetens as investors might receive a share of the retailer’s sales, amplifying their return on investment.
Mixed-Use Real Estate
These versatile properties combine elements of commercial, residential, and sometimes retail real estate. With mixed-use real estate, investors get to diversify their income channels, benefiting from the rental property income of both residences and commercial entities within the same structure.
Real Estate Investment Trusts (REITs)
REITs present an avenue for investors to delve into real estate investing without the need for direct property ownership. Essentially, one buys shares in commercial real estate via REITs. These trusts are legally required to distribute a significant chunk of their income to shareholders, which often translates to steady and reliable cash returns for the investor.
Raw Land Investment
In this avenue, investors purchase raw land, banking on its appreciation over time. Some might even develop this land, further boosting its value. ROI calculations in this segment weigh factors like location, future developmental scope, and demand.
What are the Types of Returns from Real Estate Investments?
Let’s begin a comprehensive breakdown of the subject by looking at a few key terms related to ROI.
1. Rental Income
This is the most common, and often the primary, way that investors make money on real estate investments. Whether from a residential property or a commercial asset, rental income provides a steady cash flow. Essentially, the annual rental income is what a tenant pays the property owner for the right to use or occupy that space. Deducting maintenance costs and other operating expenses from this gives us the net operating income, a critical measure for any real estate investor.
2. Property Appreciation
Over time, the fair market value of investment properties often increases, aka appreciation. This can come in the form of natural appreciation, due to market factors, or forced appreciation, due to factors such as renovations, improved operations, and so on. This appreciation in value provides investors with a return on their money, especially when/if they decide to sell.
3. Cash on Cash Return
This metric evaluates the return on the actual cash invested in an investment property. It is calculated as money cash flow as a factor of total capital invested. It gives investors a clearer perspective on their investment strategy’s efficiency in the real estate market.
4. Dividends from Real Estate Investment Trusts (REITs)
These are firms that own, operate, or finance income-producing real estate. Investing in real estate investment trusts offers a way to gain exposure to real estate without buying property. REITs provide dividends from the income generated, offering an alternative return avenue for investors.
5. Net Operating Income (NOI)
This is the total revenue from a property after operational costs. For investors, this figure is crucial because it showcases the profitability of a given asset before taxes.
While some investors may prioritize the consistency of rental income, others might lean towards the potential of property appreciation in a burgeoning real estate market, while others yet may prefer something else. These preferences depend largely on investment goals, risk aversion, available capital, and more. Regardless of the approach, understanding these return types will assist you in crafting a robust investment strategy. The end goal is to optimize the average ROI which will potentially ensure a sound financial trajectory for your investment.
Factors That Impact Real Estate Investment Returns
ROIs in real estate are affected by a myriad of interconnected factors. Whether it’s a single-family rental or a sprawling commercial property, the potential profitability of all investment properties is influenced by these determinants.
Property Price
A property’s purchase price lays the foundation for ROI on real estate. Higher initial costs can erode returns, especially if the local market undergoes a downturn.
Down Payment
The down payment affects the amount of cash invested upfront. A higher down payment reduces the loan amount, which may positively influence cash flow and overall return on investment. A higher down payment may also result in a lower cash on cash return, so be sure to be thorough during your due diligence.
Interest Rates
Interest rates impact monthly mortgage payments and the cost of borrowing. A rise in interest rates can increase monthly expenses, affecting the annual operating expenses and subsequently, the ROI in real estate. Purchasing an interest rate cap may be a viable option for some investment strategies.
Property Management
Effective property management can enhance the value and appeal of rental properties. Inefficient management, conversely, can dent cash flow and overall returns, or, worse yet, damage and investors reputation.
Annual Operating Expenses
These are the costs associated with maintaining a property; they include repairs, utilities, and property management fees, to name a few. Higher expenses can dampen cash flow and reduce the ROI on real estate.
Capitalization Rate
Often termed as the ‘cap rate’, this measures the potential return on an investment property. It’s calculated by dividing the net operating income by the property price. A higher capitalization rate usually signifies a better investment opportunity.
Cash Invested
The amount of personal cash invested in a property influences the risk level and potential returns. Leveraging more personal cash may lead to higher immediate returns but might limit investment strategies across multiple properties.
Market Dynamics
Fluctuations in the stock market, shifts in interest rates, and broader economic trends can indirectly influence property values and investment returns.
Type of Property
Different property types, such as single-family homes versus commercial properties, offer varying returns. Factors like demand, maintenance costs, lending terms, and tenant stability play roles in these distinctions.
Acknowledging and adapting to these factors allows you to make better investment decisions. Strategically managing elements like the purchase price, down payment, and annual operating expenses will additionally optimize the ROI.
How Can Real Estate Investors Get Above Average Returns?
Navigating the intricate world of real estate investment is no easy feat. However, savvy real estate investors often outpace the average ROI in real estate by implementing strategic approaches. So, how can they achieve these above-average returns? Let’s break it down.
Having a Sound Investment Strategy
An astute investment strategy is at the core of successful real estate investing. Whether you’re dealing with commercial real estate, single-family homes, or rental properties, understanding and tailoring your investment strategies to the real estate market’s current conditions can make a notable difference in ROI on real estate.
Diversifying Your Investment Portfolio
Diversification is an investing golden rule. Spreading capital across residential real estate, commercial properties, and real estate investment trusts, along with additional non-real estate related asset classes, can help mitigate risks. This diverse approach often results in steadier and higher investment returns, as well as increased downside protection.
Thorough Due Diligence During Property Selection
Purchasing properties below fair market value can significantly boost cash on cash return. Research is paramount: dig into property reports and rental agreements, consider the potential rental income and compare to like-kind properties, analyze the market for future growth (job and population) trends, and weigh the purchase price against the expected returns. Aim for properties with high capitalization rates. Conservative underwriting, in-market broker relationships, and third party analysis are also key elements to consider during the due diligence phase.
Efficient Property Management
Effective property management can elevate a property’s net operating income. This means minimizing maintenance costs, ensuring consistent rental income, reducing vacancy rates, deploying effective marketing strategies, and so on. Whether it’s a residential property or a commercial real estate asset, efficient management is key. Third party and in-house property management are both viable options, but not necessarily one-size-fits-all.
Enhance Property Value
Strategically investing in property upgrades can boost its value, ensuring higher rental rates and a better resale price. This not only increases annual rental income but can also elevate the property’s valuation in the market.
Stay Up To Date with Market Trends
Real estate investors who remain informed about stock market fluctuations, interest rates, and housing market dynamics can better predict how these factors might impact their real estate investments.
Leverage Tax Advantages
Real estate investment offers numerous tax benefits. By maximizing these benefits, real estate investors can effectively boost their annual returns. This includes, but is not limited to, deductions on property expenses, accelerated depreciation, 1031 exchanges, and understanding the nuances of real estate investment trust dividends.
Optimize Operating Costs
Minimizing annual operating expenses is a straightforward route to enhancing ROI. This involves negotiating better terms with service providers, implementing energy-saving measures, regularly reviewing insurance costs, bringing services in house, and/or creating economies of scale by owning multiple assets in the same geographical area and leveraging the same service(s) or service provider(s) for all properties.
Always Keep an Exit Strategic
Knowing when to sell is as vital as knowing when to buy. Timing exits to coincide with market highs can ensure that real estate investors realize above-average ROI from their property investments. Equally as important is knowing when not to sell, or to hold during a downturn to protect capital.
In conclusion, while the allure of real estate investmenting is evident, achieving above-average returns necessitates a blend of strategy, market knowledge, and efficient management. By integrating these principles, real estate investors can consistently outpace the average ROI and fortify their financial portfolios.
How Do I Calculate Real Estate ROIs?
Achieving success in the real estate realm hinges on understanding the metrics behind your investments. ROI, or Return on Investment, serves as a cornerstone in evaluating an investment’s performance. Here’s how to calculate various types of ROI.
1. Basic ROI
To find the basic ROI:
Formula: [ (Current Value of Investment – Cost of Investment) / Cost of Investment ]
For example, if you purchased a property for $200,000 and its current value is $250,000, the ROI would be:
[ ($250,000 – $200,000) / $200,000 = 0.25 or 25% ]
2. Cash on Cash Return
This metric offers insight into the return on the actual cash you’ve invested.
Formula: [ Annual Cash Flow / Total Cash Invested ]
Suppose you invested $50,000 (down payment and other initial costs) and your annual cash flow from the property is $5,000. The cash on cash return would be:
[ $5,000 / $50,000 = 0.10 or 10% ]
3. Capitalization Rate (Cap Rate)
The cap rate provides a snapshot of the potential return on a real estate investment, devoid of mortgage considerations.
Formula: [ Net Operating Income / Current Market Value ]
If a property valued at $400,000 generates a net operating income of $40,000, then:
[ $40,000 / $400,000 = 0.10 or 10% ]
4. Total Return on Investment
This calculation encompasses all forms of return, including cash flow, equity, appreciation, and tax benefits.
Formula: [ (Annual Total Return / Initial Investment) x 100 ]
Consider that over a year, your total returns (cash flow + equity + appreciation + tax benefits) amount to $20,000, and your initial investment was $100,000. Thus:
[ ($20,000 / $100,000) x 100 = 20% ]
Summary of ROIs in Real Estate
ROIs in Real Estate serve as an important metric for you as an investor. It will guide your decisions and influence long-term financial trajectories. Maximizing returns requires a keen understanding of market dynamics, paired with the execution of an effective investment strategy. By consistently refining your approach and remaining adaptable to changing circumstances, you will be able to fully harness the potential of your real estate endeavors.
Bishop Investing Group is an alternative real estate investment firm that focuses on offering strong ROIs to investors via commercial real estate syndication deals. This is an opportunity for investors who are looking for a less time-intensive approach to investing. To date, we have participated in over 30 projects that would accumulate to a $1.2+ billion real estate portfolio of commercial assets with the potential for attractive returns. For an opportunity for wealth creation and portfolio diversification through real estate syndication, book a call with Michael Bishop today.
Frequently Asked Questions about ROIs in Real Estate
DISCLAIMER:
Real estate investing comes with a variety of risks including rising interest rates, lower than expected occupancy and the operator’s failure to execute the renovation and rental increase business plan. Real estate investments are also illiquid which means there is no readily available market for an investor to sell their interest in a real estate syndication. Investors are typically required to be deemed an accredited investor. As with any investment, there is the risk that the entire investment may be lost.
