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When computing potential returns on investments in real estate, with what assumptions should I be concerned?
When you are analyzing any real estate deal, you need to concern yourself about your assumptions, such as what you believe is the value of the property, and what the market says the property is worth. You can review a bank appraiser's appraisal, but ultimately a buyer and a seller determine a property's final price or value. So you should underestimate a house's value when analyzing possible return models.
There are many costs inherent in real estate investing that you should capture in order to calculate your returns accurately. Those additional costs may include: property taxes paid; insurance costs; costs to advertise the sale of the property; sales and listing fees and commissions of the real estate agent or broker; and financing charges related to discharging the loan. You should
When calculating your Return on Investment (ROI), divide the money you get back (return) by your total costs into the investment to get a percentage or ratio.
discuss the transaction with an accounting professional to understand fully all the expenses related to a real estate transaction.
What are some limitations to using ROI models in order to understand my returns on real estate investments?
You can further complicate the simplistic return models by using variable interest rate loans or interest-only loans, by refinancing the original loan, or by extracting equity from the property by obtaining a second mortgage.
According to experts at Zillow, returns on any type of real estate investments fundamentally depend on two important factors: operating the investment so that it generates cash and income to the owner, and the property's appreciation over time. Since it is difficult to know in advance when you might sell a property, or at what future price you may sell it, experts generally agree that potential investors should focus their analysis on the cash flow and income-producing characteristics of the investment.
Cash- on-cash analysis allows you to understand the income compared with the amount of cash invested before making any tax considerations. To calculate your cash-on-cash return, first add all income generated from the investment, such as monthly rents and fees, and subtract your monthly expenses to give you a rough estimate of the income the property may generate. You should also subtract your monthly loan payments to compute your annual income.
If you purchase the property with a loan, if you use a down payment, and if you make one-time renovations, add these numbers to estimate the initial costs associated with purchasing the property (the property's "equity cash.") Then divide your annual income by your equity cash figure and multiply by 100 to see the cash-on-cash returns as a percentage.
Zillow notes that many real estate investors fail to make these and many other basic calculations, preferring to "wing it" when investing in real estate. Relatively simple calculations will remove much of the mystery and luck from the equation, and improve your chances for success.
Are there any online calculators that will allow me to calculate returns on potential real estate deals easily?
There are many online calculators available on websites that will allow you to see and understand potential returns from a real estate transaction. However, each calculator may use different variables in its equation, including such important items as calculations and terms of amortization, depreciation, mortgage interest paid, interest rates, property taxes, occupancy rates, analysis duration (the duration of time over which you review the data may greatly influence your results), and your tax bracket information.
The more variables you try to capture, the more accurate your estimate will be regarding your potential returns.
Many real estate investors use a cap rate to understand the amount of income generated, compared with the amount of cash expended to acquire the investment. It is computed by dividing your net operating income assumptions by your cost of purchase, expressed as a percentage. If your investment property earns $12,000 per year, and you purchased it for $100,000, your cap rate would be 12%.