How to Calculate Return on Investment
We have to determine what the return on investment (ROI) will be before investing in any project. It is too late to calculate the numbers after you have purchased the property.
Return on investment is calculated annually. ROI tells us how much we are going to make from cash flow and appreciation over the next 12 months.
In order for us to calculate the ROI for a project, for example, over the next five years, we have to make an assumption as to what the future rent increases will be and what the future appreciation of the property will be. We have to determine the past performance and present value of the property.
To get the past performance on rents we have to talk to a property management company to find out what the fair market rent was 3 years ago, 2 years ago, and 1 year ago. Once you have this, then you need to get the value of the property for 3 years ago, 2 years ago, and 1 year ago, as well as the present value.
Let’s assume the rent increase was 3% per year and let’s assume the value increase was 5% per year. We have to look at the leading economic indicators to make an assumption on future growth. Leading economic indicators are per capita income, population, building permits, apartment occupancy, office occupancy, and new businesses. If these have been increasing over the last three years, it is reasonable to assume that we will have the same rent increase and value increase that we have had in the past. If these were flat for the last three years, then the future rent increase and growth will probably not increase any further, because these indicators are not increasing.
You determine the ROI by determining your annual cash flow and your annual appreciation. Once you have these two numbers, you divide them by the purchase price. This will give you your ROI.
Running the numbers on a property is easy when you know what to look for. For more information on how to run the numbers on a property, visit our prior posts or come to the Rich Dad Education Elite Creative Financing Course.
Richard Maryanski and Erik Maryanski
Rich Dad Education Elite Trainers and Mentors