Real Estate Investing – How to Calculate Return Rate Using the Five Components of Return

How do you know that one real estate investment is better than another? Obviously, you must have some numerical way of judging one investment over another. That method is called real estate return rate!

Many real estate investment companies have no idea how to calculate the true return rate. That is unfortunate, especially in real estate investing for beginners. In today’s market, particularly, if you pick the wrong investment or invest in it in the wrong way you can lose hundreds of thousands of dollars.

There are tons of property opportunities…but which is the right one for you? There are five components of realty return. I’ll go over them briefly here so you can endeavor to find the best realty investments.

First, is appreciation. If your particular area goes up 5% and your investment property is worth $200,000 then you will have made $10,000 (5% x $200,000). Keep in mind that appreciation could well be negative as well and you might have to deduct $10,000.

Second, is cash flow. If you’re renting your property for $1,000 per month and your expenses and mortgage payment is $800 per month then you cash flow would be $2,000 per month or $2,400 annually.

Third, is principal pay off. Every time you make a payment, if you have a mortgage loan, then you are paying off principal. Since the principle deducts from your loan balance then you can add that as a component of return. Let’s say that you pay off $2,000 of mortgage principle for the particular year.

Fourth, is tax benefit. If you can depreciate $10,000 on your investment and you’re in the 50% tax bracket, then the tax benefit to you is $5,000 in real dollars.

Fifth, is something that I coined in my book thirty years ago. It is called equity discount. If you buy a property for $200,000 and immediate re-sell the property for $250,000 you have made $50,000.

That difference is called equity discount. Keep in mind that equity discount can be a negative number as well if you are buying a property for more than it is worth. Why would you do that? Trust me, sometimes that are good strategies to do that.

Now, if we add all the components together, we get $69,400 ($10,000 appreciation + $2,400 cash flow + $2,000 principal pay off + $5,000 tax benefits + $50,000 equity discount).

Now, we divide the $69,400 by the down payment. Let’s say you put $25,000 down on the property. If you divide $69,400 by $25,000 you get 277%. Wow! That is way more than you could get from an investment trust or through your bank.

What if you could buy the property for no down? Your return rate would be infinity! What if you could buy it for no down and put cash in your pocket? That’s another topic to consider.

Good luck in your investing pursuits!

By Martin Fisher

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