Calculating return on investment equals Net Operating Income/Cost of Property
“Men lie, women lie, but numbers never do. Know this and know peace in your investing journey.”
If you are interested in investing and have been doing research about #realtorsinnigeria, then you will have either read their content or watched their videos and in at least 90% of them will you find the promise of a ‘good Return On Investment’, ROI.
Your thought might be: “What is this ROI and is it always as good as they say it is?”
My response to this would be: “Work the numbers and find out for yourself. This should be the basis for which you are investing. Unless you are just buying a house and you are ready to spend all your free money on it (PS: that is not investing but buying residential property for you to live in – note the difference).”
As a potential investor, if you are truly looking to invest in real estate and make money/create wealth from it, then ROI is what your investment buying decisions should be based on. But sometimes and in some cases, it’s not always black and white and it definitely may not be as you expect or even want it to be.
Let’s start with what ROI actually is, and then we will move on to how we get to calculate it.
Investopedia defines Return on investment (ROI) as a performance measure used to evaluate the efficiency or profitability of an investment or compare the efficiency of a number of different investments.
To calculate return on investment, ROI, the benefit (or return) of an investment is divided by the cost of the investment.
Using real estate, let’s presume that you want to calculate the ROI on a property you are about to invest in, this is what you will be needing to do to calculate your return on investment.
ROI = Net Operating Income/Cost of Property.
*Please note that Net Operating Income (NOI) is calculated by Annual rental income – (Costs + Expenses)
Depending on the reason why you are needing to know your ROI, you will then need to introduce the factor of time/duration as well. For global real estate investors, the calculation could be drilled down to as low as per week – this also works for short-let apartment analysis.
Here is a practical example using an average 2-bed apartment in the Ikate-Lekki area
| LINE ITEMS | AMOUNT | DESCRIPTION |
| Cost of the property | 48,500,000 | Price bought + fees estimated |
| Annual rental income | 2,500,000 | Current market rate |
| Service charge per annum | 1,200,000 | Paid by the resident tenant |
| Maintenance fees per annum | 300,000 | Estimated for years 1 – 3 |
To calculate the ROI on this apartment for the first 3 years, your numbers should look something like this
- NOI: 2,500,000 – 300,000 = 2,200,000
- ROI: (2,200,000/45,000,000)*100 = 4.88% per annum
Assumptions made here include the fact that the cost of the property remains the same in the first year at the least. To calculate this year on year, you then need to factor in the estimated value appreciation that the property will experience and use that new numbers to calculate what your ROI would then be.
Note that the basic reason you are investing in real estate is to create wealth, put your money to work and generate cash flow. Knowing your numbers will help you to budget how much less f your actual income it is that you are either not spending or how much more of it that you will have as disposable income to pay for other things like pay for yearly vacations, a new course or even pay a part of the rent where you are currently living.
A smarter way to invest in properties and earn higher ROI is to buy low and resell.
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For people who are investing for the purpose of reselling, the numbers you need to know will also be different because the period at which you want to resell will determine if your ROI is calculated inclusive of the NOI factor or not. For example, early investors to off-plan properties are able to leverage the development timeline to make an ROI of up to 20%, here is why and how.
- They bought really early and at the lowest possible price that the property would ever be.
- They probably bought and paid via instalments which means that some of them might not even have finished paying for the unit by the time they are negotiating the resell.
With off-plans, this is the point at which factors like reliability, timing and design outcome are the most critical and present the highest risks; it’s also why people who are ardent early investors tend to be the ones with the lowest aversion to risk. The way they would most likely need to calculate their return on investment is called the Out of Pocket method.
ROI = Annual Cash Flow / Total Cash Invested
The annual cash flow is obtained just like the basic method but with the monthly mortgage payment and cost expenses deducted from the rental income. The major difference here is the denominator which is the total cash invested instead of the property value.
If you are anything like some of the clients I have walked through this calculation, the next question on your mind would be ‘What makes a good ROI?’
The simplest answer is “YOU determine this”
Your reason for wanting to invest in the property, how easy it is for you to come up with the cash investment needed and the timeframe you will need to work the asset are factors that you need to assess especially in view of your portfolio as a whole.
Does the return on investment make numbers sense to you in line with your goals?
That is what truly matters.
Excited to hear back from you on the information shared in this article, I encourage you to comment below or connect with me here to share your feedback.
Till next week, its bye for now.
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