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How to Calculate ROI for Property Investments

How to Calculate ROI for Property Investments

 

First, we need to understand “Deductions”

What is a ‘Deduction’

A deduction is any item or expenditure subtracted from “Gross Income” to reduce the amount of income subject to Income tax. It is also referred to as an “allowable deduction.” For example, if you earn $50,000 and claim a deduction for $2,000, then your taxable Income is reduced to $48,000.

BREAKING DOWN ‘Deduction’

The Internal revenue system offers a host of deductions. In the United States, tax payers have the choice of claiming the standard deduction or itemizing their deductions.

Return on Investment (ROI) is an accounting term that indicates the percentage of invested Money that’s recouped after the deduction of associated costs. For the non-accountant, this may sound confusing, but the formula may be simply stated as follows: 
But while the above equation seems easy enough to calculate, with property Investments a number of variables, including repair/maintenance expenses, and methods of figuring Leverage i.e. the amount of money borrowed (with Interest) to make the initial Investments– comes into play, which can affect ROI numbers. In many cases, the ROI will be higher if the cost of the investment is lower. When purchasing a property, the terms of financing can greatly impact the price of the investment; however, using resources like a Mortgage Calculator can help you save money on the cost of the investment by helping you find favourable or competitive interest rates.

The Cost Method

The cost method calculates ROI by dividing the “Equity” in a property by all costs.

As an example, assume a property was bought for $500,000. After repairs and refurb, which costs an Investor an additional expense of $50,000, the property is then valued at $700,000, making the investors’ equity position in the property $150,000 (700,000 – [500,000 + 50,000]).

The cost method requires the dividing of the equity position by all the costs related to the purchase, repairs, and rehab of the property.

ROI, in this instance, is $150,000 ÷ $550,000 = 0.27, or 27%

The Bottom Line

Calculating ROI on property Investment can be simple or complex, depending on all the variables mentioned above. In a robust economy, real estate investments, both residential and commercial, have proven to be very profitable. Even in a recessionary economy, when prices fall, and cash is scarce, many bargains in real estate are available for investors with the money to invest. When the economy recovers, as it invariably does, many investors will reap a handsome profit.

For Income Tax or Capital Gains Tax (CGT) purposes, however, Investment property owners are urged to get professional accountants advise.

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