If you’ve ever considered buying a property, then you definitely heard about the term Return on Investment (ROI). In fact, ROI is the major factor both amateur and experienced investors look at first! It’s a powerful tool that allows you to determine if a certain property serves as a good investment or not. But what exactly is ROI in real estate? How is it calculated? Where do you invest to achieve a high ROI? Everything you need to know about real estate ROI will be explained in this blog.
What is real estate ROI?
ROI is an important metric, measuring the profitability of an investment, or in other terms, measuring the expected returns relative to the cost of the property. Essentially, the ROI helps you evaluate whether a particular property is more likely to generate healthy returns and serve as a good investment opportunity or not.
To calculate the ROI, you can simply take the gain on the investment, subtract from it the cost, and then divide that number by the cost of the investment. The formula can be as simple as this:
ROI = (Gain – Cost) / Cost
If you invested $180,000 in a house and sold it after a few years for $330,000, then your ROI would be:
(330000 – 180000) / 180000 = 0.83 = 83%
What to consider when calculating the ROI
Now, the formula may seem easy to calculate. However, there are a number of variables that come into play when calculating real estate ROI. For example, the amount of money borrowed and the interest rate can greatly impact the cost of your real estate investment and ultimately, the overall ROI. Additionally, the following factors may further complicate your real estate ROI calculations, if not taken into account:
- Property Details: includes repair costs, property value, number of rooms, square footage, and other crucial aspects.
- Payment Details: this could be the loan terms, downpayment, and interest rates.
- Rental Income Details: depends on expected vacancy rate, type of rental period whether it’s short-term or long-term and monthly/yearly expenses. (E.g. property management costs, utilities, maintenance, service charges, insurance costs, and taxes)
- Net Operating Income, NOI: is simply calculated by subtracitng: gross income – operating expenses of the property.
- Capitalizaton Rate: also known as the cap rate, helps you gain a clear insight to compare different investment opportunites. It is essentially the rate of return. You can calculate it by dividing your NOI by the price of the property.
- Annual Cash Flow: this is basically how much you will potentially profit or lose from a property after covering expenses.
I’ve included rental details since you would ideally be looking for a residential property that would generate a second income for you. So, learning about all this information can easily help you decide whether this property is a good investment – depending on your long-term goals. Remember that there is no right or wrong answer when it comes to real estate ROI calculations.
Different people opt for different levels of risk. A property may seem to exhibit great rental income potential but might have hidden fees or extra charges you were oblivious to. Sometimes the property’s value increases faster than the rate of rent in a certain area, meaning this would generate lower rental income for you. So, it all comes to what you are aiming for. Are you looking for a property that substantially appreciates in value later on or are you looking to generate an immediate rental income?
Tips for achieving high ROI
According to our yearly reports and statistics, the following types of properties generated higher ROI and proved to be more lucrative than others.
- Apartments Vs. Villas: apartments typically provide higher rental yields than townhouses or villas, due to Dubai’s highly transient, mid-income population. Expats usually look to rent apartments as they are just starting to build their careers. Apartments are also more centrally located, so they can also serve as great holiday homes.
- Ready vs. off-plan properties: In reference to figure 1 below, there is a huge gap between ready and off-plan properties transactions, with ready properties taking the lead as investors are inclined towards less risky investments.
- Smaller-sized apartments vs. larger apartments: based on our reports, studios and 1-bedroom apartments performed better than larger units. In particular, studios and 1BDR apartments with established infrastructure in affordable communities, close to essential amenities are a high priority for investors. Besides, smaller units are sold faster and offer better value since the majority of Dubai’s population can afford to purchase these units.
- Prime Vs. affordable areas: affordable areas usually perform better, like JVC in Dubai for example. People look to rent in JVC due to its good quality and affordable apartments. So, properties in such areas are more likely to generate high rental yields as long-term rentals in comparison to prime areas.
If you’re interested in looking at the best-performing areas in Dubai for real estate investments, click here.
The Bottom Line
Your real estate ROI will vary depending on the decision you make. It’s important investors are mindful of the variable factors affecting ROI calculations to plan their investments accordingly. At SmartCrowd, we make sure investors learn about all the necessary information related to the property and its location. Even more interesting, SmartCrowd has a free real estate investment calculator which you could use to calculate expected earnings. So, what are you waiting for? Now that you have learned everything you need to know, it’s time you begin your real estate investment journey?