How to Calculate ROI for Real Estate Investments

ROI or Return on Investment is a term to describe how much you profit from an investment. It is the percentage of money made on an investment after all the costs associated with that investment are subtracted. So, if you invested $10 and earned $1, your ROI would be 10%, assuming you get your original $10 back.

The basic equation is: [ (Gain – Investment Cost) / (Your Cost) ]

Let’s look at the two basic methods of applying this equation to real estate investments:

1. The Out of Pocket Method

Suppose you purchased a house for $100,000. The needed rehab was $60,000 and the eventual selling price was $200,000. Let’s also assume that the investor only had to come up with a $10,000 down payment and the rehab costs.

The ROI would be: [($200,000 – $160,000) / $70,000 ] = ~57%

2. The Cost Method

Let’s use the same imaginary situation, but the investor paid for everything with his own money.

The equity in the property is $40,000 (200,000 – 100,000 – 60,000= $40,000).

The ROI would be $40,000 / $160,000 = 25% (A 40k profit on 160k spent).

The first method allows for the use of leverage, so it might seem better to borrow as much as you can. But consider that that actual amount of money you would make would be greater in # 2, since there wouldn’t be any costs associated with the loan. So your rate of return might be lower, but the number of dollars in your pocket would be greater.

Which method you choose is up to you. The point is to stick to one method when comparing different prospective investments. ROI can be an excellent tool to determine which deal is better than another.

Other Considerations

Don’t be concerned with equity in your calculations; it’s better to be concerned with the amount of money you are left with at the end. You need to consider all your expenses, such as:

* Property taxes that you have to pay
* Insurance while you’re holding the property
* Utilities
* Interest on any loans
* Closing costs, both to buy and to sell the property
* Real estate commissions when you sell
* Mowing the grass until the property sells
* Appraisal and inspection costs
* Costs for repairs – both materials and labor

The real estate shows you see on TV rarely address all these costs. All they talk about is the purchase price, cost of repairs, and the selling price. As you can see, repair costs are only one of many costs that you may be responsible for. Those shows have nothing to do with reality. Be sure you’re subtracting all your expected costs when you do your calculations.

Also consider time. Is a 40% return in 12 months better than a 20% return in 12 weeks? In most cases, no, it is not. Just be sure to consider the time period when you’re making comparisons.

Also consider cash flow. In the case of an apartment building, your ‘gain’ would be the rents that you collect over the course of a year. But be sure to include a vacancy rate in your calculations. There are also greater costs associated with owning rental properties: repairs in the middle of the night, painting between tenants, advertising, carpeting, landscaping, and more.

Getting an accurate ROI estimate really isn’t possible in real estate. You never truly know your future selling price or how long it will take. Repair estimates can be off as well. That’s why it’s important to estimate high on your costs and low on the income. Be conservative and you’ll always be pleasantly surprised in the end!

Common Real Estate Investing Mistakes

Although real estate may seem like a sure bet for anyone, many investors make the same few mistakes. Eliminate these errors from your investing activities and you’ll be well on your way to accumulating the wealth you desire.

Avoid These Real Estate Investing Mistakes

1. Poor research. Most of us do a lot of research when we plan our vacations or purchase a new television. If you were buying one that was worth 100k, you can bet you’d do even more research! Well, you should be doing that when you purchase a piece of real estate, too.

2. Inadequate financing. Real estate investors frequently like to wheel and deal, and their deals can have a lot of moving parts. Balloon payments, interest-only payments, owner financing, subject-to, and many others are commonplace.

* To make a deal happen, we can get carried away doing everything in our power. Getting a great price doesn’t always justify the deal if the financing is inadequate. Are you really sure that you can unload the property or get other financing before that balloon payment comes due?

3. Trying to do everything yourself. Though every real estate investor attempts this at one time or another, you have little chance at success all by yourself. A great investor will have, at a minimum, a real estate agent, attorney, title company, inspector, handyman, and insurance agent – all on speed dial.

* You may not always need them, but they should already be in place, and you shouldn’t hesitate to call them if you do want their services. Use your experts to your full advantage.

4. Paying too much. This one is certainly related to doing enough research. Real estate deals primarily sink or swim based on price. If you pay too much, not much can be done to rectify the situation.

* Beginning investors are more likely to mentally fudge the numbers a little bit to make a deal happen. But if the repairs run high, and the price they can sell for is lower than expected, then overpaying in the first place can be disastrous. Do your research and your math and stick to your numbers.

5. Not estimating expenses accurately. This is similar to paying too much. Many investors will look at repairs and think to themselves, “Everyone is saying it will take $20,000 to fix, but I’m sure I can get it done for $14,000.” But what if it really takes $23,500? That’s part of the reason getting the property at the right price is so important.

* The other aspect of this mistake is not accounting for all expenses. The costs of landscaping, lawn mowing, insurance, utilities, property taxes, and new appliances can really add up in a hurry. Be realistic with your repair planning and take careful notes of all your possible expenses.

Real estate investing is a relatively simple business, but mistakes can create massive challenges in a hurry.

Every seasoned investor has made all of these mistakes. The best investors just make them less often than everyone else. In any housing market, there are moneymaking opportunities, so don’t let these mistakes slow you down!

Withdrawing Your Traditional IRA Funds

An important age to remember is 59 1/2 years in regard to your IRA. Why? Because, if you haven’t yet reached that magic age and you withdraw IRA monies, the IRS will charge you a 10% penalty on the amount you withdraw in addition to income taxes on the withdrawn amount. However, in certain circumstances, you can withdraw IRA funds early without a penalty.

Exceptions to the Withdrawal Penalty Rule

1. Active military reservists. Active military reservists can withdraw from their Traditional IRAs without penalty at any age. There are specific conditions to be met under this exception, including that you must be serving active duty at the time you make the withdrawal.

2. Education costs. If you’re paying for education-related costs for yourself, your children, grandchildren, or spouse, you can withdraw your traditional IRA funds early without penalty. 

* Ensure that you check the IRS’s rules about this exception, as the school attended must meet their mandated requirements.

3. A first home purchase. You can use up to $10,000 of your IRA funds without penalty if you use the money to help purchase your first home. If you’re married, your spouse can also withdraw $10,000 from his or her own account as well. 

* Technically, you could have owned a home before purchasing the home you’re hoping to use your IRA funds for. However, you can’t have owned or lived in a home you owned for 2 years prior to the time you’re using the funds to buy a house. 

* If your spouse owns the home you live in, you can’t tap into your IRA funds without penalty for a home purchase. 

* You’re required to use the funds within 120 days of obtaining them. 

* You can use your IRA money as a down payment on a home for your children, grandchildren, or spouse, as well as yourself. 

4. Other qualifying events. You may also withdraw from your IRA without a penalty if certain events occur: 

* If you become totally disabled, your IRA money is available to you without penalty. 

* If you aren’t employed, you can withdraw from your IRA to pay your medical insurance payments. 

* If you’re the beneficiary of the IRA and the IRA holder dies, you can receive IRA payments. 

* Also, if you have unexpected, “excessive” medical bills, you can access your traditional IRA money to pay them.

If you withdraw your IRA money for any of these reasons, you’ll most likely need to complete IRS Form 5329 to inform the IRS about why you withdrew the money. Also, remember that in all these cases, you must still pay income taxes on the amount you withdraw, just not the 10% penalty.

When You’re Required to Withdraw Your IRA Funds

By April 1st of the year you turn 70 ½ years old, it’s required that you begin to pull out your IRA money. The IRA has required minimum distributions (also known as RMDs). If for some reason you haven’t begun withdrawing your funds by age 70 1/2, the IRS will tax you a significant amount of money each year you don’t take your money.

Ensure you know when and how to withdraw your traditional IRA funds without penalty. Effectively managing your money as you approach your retirement will make the difference between good and great golden years.