Acquiring rental properties is a common investment opportunity. When investing in real estate, you are looking for a positive ROI (return on investment) so that you can profit and build up your wealth.
So, what is ROI real estate? As an investor, you determine the real estate investment balance by evaluating the profit versus the costs of the investment. You also look at the property's income-producing potential. Knowing how to calculate ROI in real estate can help you determine whether the property is a worthwhile investment option.
Real estate auctions are a great place to find real estate investment opportunities. As with any investment, there are some things to consider. Investors who bid on foreclosure homes, for example, are bidding on a house in as-is condition that may need improvements to make it livable. The same can be true for bank-owned properties at auction.
The Different Real Estate Valuation Methods
Variables such as repairs, maintenance, utility rates, and increasing property taxes can affect the ROI on an investment property. Since there are several variables to consider with rental properties, such as vacancy rates and the variables mentioned above, you’ll want to know about the following real estate valuation methods.
Investors use the cap rate, or cost method, to determine the ROI on investment properties. To get your ROI using the cap rate, you divide your net operating income by your total investment.
The Market Extraction Method
Finding the cap rate by the market extraction method assumes that there is no Net Operating Income (NOI) available. In other words, the investor cannot find available sale price information on similar properties that are generating income.
The Build-Up Method
The build-up method is one of the most common ways to calculate the cap rate. First, you start with the interest rate. Then, you add the suitable liquidity premium (assets you can't sell for cash without a loss), recapture premium (adjustments for appreciation or depreciation of the property), and the risk premium. The cap rate will be the total of these.
The Band-of-Investment Method
The band-of-investment method is one of the most reasonable cap rates for investors who finance their real estate investment. To determine the cap rate, investors must compute the individual interest rates in properties that use both equity financing and debt.
While appraisers use several methods to value properties, the three most common are the market comparison approach, income or investment approach, and the cost approach.
The market comparison approach compares the value of the property with similar ones actively being sold in the area.
The income or investment process appraises how much the property is already generating and what it could generate in the future.
The cost approach looks at what it would cost to build a similar property.
Roadblocks to Real Estate Valuation
Trying to determine the value of an investment property is time-consuming and easier said than done. You’ll need to gather critical information to calculate the different formulas. The information must include NOI, cap rate premiums, and sales data comparisons.
*Note that significant changes in the real estate market, such as a real estate boom or a credit crisis, are not factored into valuation models.
Discounting Future NOI
Things to consider when discounting future NOI include the threat of vacancy rates. There are also operating expenses to consider, such as property insurance, maintenance fees, utility costs, and other expenses that are a part of the day-to-day operations of your investment property.
Gross Income Multiplier
Investors use the gross income multiplier (GIM) method to appraise their investment property. Although it’s a rough measure, you can find the value of your property by dividing the property value by the total income received from the property, such as rent. For instance, if the gross annual rental income the property generates is much higher than its market value, it can be an attractive investment.
What Is a Good ROI in Real Estate?
Not every investor agrees on what a good real estate return on investment is. Most real estate investors have a goal of reaching an ROI that’s comparable or one that surpasses the S&P’s 500 average returns, which is historically set at 10%.
Use a Trustworthy Auction Site to Find Investment Properties
When it comes to finding an investment property, you’ll want to use a reputable real estate auction firm, such as ServiceLink Auction. At ServiceLink Auction, you can search through our nationwide list featuring foreclosures, newly foreclosed, short-sale, and bank-owned property listings.