What ROI should you plan for when you buy real estate?

Thinking of buying real estate in the United States? We have financial spreadsheets tailored to 700+ cities.

Property investors want to know their ROI because it shows how profitable their investment is. Knowing the ROI helps them decide where to invest, understand the risks, and compare different properties.

If you're curious about calculating your ROI and other important metrics like NOI, rental yield, and cash flow, we have spreadsheets designed for over 700 cities in the US.

These spreadsheets come with a built-in ROI calculator. Want to see how it works? Download a free sample here.

What ROI should I plan for when I buy a property?

It depends on the number of years

Your expected ROI heavily depends on how long you hold the property.

Achieving 150% ROI in 10 years is solid; over 30 years, it's underwhelming.

Indeed, achieving 150% ROI in 10 years equates to an annualized return of approximately 9.62%. In 30 years, we get an annualized return of approximately 3.21%, or 3 times less.

To make it clearer for you, we have prepared a table showing the annualized ROI over 5, 10, and 30 years for various overall ROI percentages.

It depends on the returns you could achieve with other investments

Now, let’s say you input your data in a well-crafted real estate pro-forma spreadsheet and it gives you an ROI of 150% for the next 10 years.

If we look at the table above, it gives us an annualized return of 9.60%.

Is it good then?

Well, consider the S&P 500, which historically gives a bit more than 7% annual returns. If your property offers a 9.6% annualized ROI, you're only slightly ahead.

But real estate isn’t passive.

You’ll deal with renovations, finding tenants, maintenance, and unexpected costs. The time and effort might not justify the marginally higher return compared to a hands-off investment like the S&P 500.

Results and projections are explained in simple English in our financial spreadsheets tailored to 700+ cities.

It depends on the amount you invest

In the end, it’s not really the percentage that matters, but how much money you have made.

Let’s continue with the example above. You made 9.6% over 10 years, and in the same time, the S&P 500 would have given you 7%.

The difference of profit is really dependent on how much you put in when you bought your property.

It depends on how you value your time

On average, you might spend around 100 to 150 hours per year on a single property.

This might seem like a lot at first glance, but let's break it down so you understand where this time goes and why it’s not as daunting as it sounds.

First, you have the regular, predictable tasks.

Each month, you’ll need to handle rent collection, which could take a couple of hours if everything goes smoothly. This includes sending reminders, processing payments, and dealing with any minor issues that might arise, like a tenant asking about a broken appliance. This adds up to about 24 hours a year.

Next, maintenance and repairs will be a consistent part of your year.

Think of things like fixing a leaky faucet, replacing a broken window, or even just routine checks to ensure everything is functioning properly. Even if you hire a handyman or a property management service, you'll still need to spend time coordinating and ensuring the work gets done. Expect to spend around 40 hours a year on this, depending on the property's age and condition.

Tenant management is another significant time sink.

Finding and screening new tenants can be time-consuming, but it's crucial to avoid problems down the line.

This includes advertising the property, showing it to prospective tenants, reviewing applications, and running background checks. This might take up to 30 hours spread over a couple of weeks, but since tenants typically sign one-year leases, it’s a once-a-year task.

Also, there’s the unexpected – those things that pop up out of nowhere.

Maybe there's an emergency repair needed, or a tenant has a significant issue that requires your immediate attention. These situations are unpredictable but can add up to another 20-30 hours a year. Having a good emergency fund and reliable service providers can mitigate some of this time, but you should always be prepared for these moments.

Administrative work is another area where time will be spent.

This includes keeping track of your finances, filing taxes, ensuring compliance with local housing regulations, and handling insurance. Budget around 20 hours a year for these tasks. Investing in good accounting software or hiring an accountant can streamline this process significantly.

Finally, ongoing education is crucial.

Real estate markets change, laws and regulations evolve, and staying informed ensures you make the best decisions. Spending about 10-20 hours a year reading articles, attending seminars, or taking courses is a wise investment of your time.

Then it depends on how much you value your time.

Let's take the example of a 10-year investment. If you spend 150 hours per year on your investment, that totals 1,500 hours. Here is how much you should make.

And here is the table over a 30-year period (4,500 hours).

A very detailed example of a ROI calculation

Imagine you’re buying a residential property in the city for $300,000.

You’re planning to rent it out and hold it for 10 years. To keep things simple, let’s say you pay all cash for the property, so there’s no mortgage involved. This makes it easier to see the pure ROI without the complexity of financing.

First, let’s look at your initial investment. This is straightforward: it's the purchase price of $300,000.

But don't forget about other initial costs like closing costs, repairs, and any renovations needed before renting it out. Let’s say these additional costs total $20,000. So, your total initial investment is $320,000.

Next, think about your annual rental income. Suppose you rent out the property for $2,500 per month. Over a year, this adds up to $30,000 in gross rental income. However, rental income isn’t all profit.

You’ll need to subtract annual expenses.

These include property taxes, insurance, maintenance, and property management fees. Let’s say these annual expenses come to $10,000. This leaves you with a net rental income of $20,000 per year ($30,000 - $10,000).

Now, over 10 years, your total net rental income would be $20,000 times 10, which is $200,000. You can put this number in your real estate cash flow template.

But we’re not done yet.

Properties usually appreciate over time. Let's assume the property appreciates at an average rate of 3% per year. After 10 years, the property’s value would increase. Using the formula for compound interest (Final Value = Initial Value * (1 + rate)^years), the property would be worth approximately $402,640. This is calculated as $300,000 * (1 + 0.03)^10.

To find your total return, you need to add your net rental income over the 10 years to the increase in property value. So, your total return is $200,000 (net rental income) + $102,640 (appreciation), which equals $302,640.

Now, let’s calculate the ROI.

ROI is the total return divided by the initial investment. Here, it would be $302,640 / $320,000. This gives us an ROI of about 0.9464, or 94.64%. This is the total ROI over the 10-year period.

To annualize this ROI, we use the formula for annualized return, which is [(1 + Total ROI)^(1/years)] - 1. Plugging in our numbers, we get [(1 + 0.9464)^(1/10)] - 1, which equals approximately 6.9%.

So, your annualized ROI is about 6.9%.

If you want to avoid doing all these calculations, input your data in one of our spreadsheets that will generate all the profitability metrics for you.

What are other real estate profitability metrics and how do they differ from ROI?

Here's a list of common real estate profitability metrics and a brief explanation of how each differs from Return on Investment (ROI)

• Net Operating Income (NOI):

  Focuses on income from property operations, excluding financing and taxes.

• Capitalization Rate (Cap Rate):

  An annualized measure of return based on property value and income, excluding financing.

• Cash on Cash Return (CoC):

  Measures return on actual cash invested, excluding financed portions.

• Gross Rent Multiplier (GRM):

  Estimates property value based on rental income, not accounting for expenses or net income.

• Internal Rate of Return (IRR):

  Considers the timing and magnitude of cash flows, providing a comprehensive view of profitability.

• Equity Multiple:

  Focuses on total returns over the investment period, measuring how many times the initial investment is returned.

• Debt Service Coverage Ratio (DSCR):

  Assesses the property's ability to meet debt obligations, focusing on financial health and risk.

• Price Per Square Foot:

  Standardized measure of property value, focusing on valuation and market comparison.

• Payback Period:

  Measures the time required to recover the initial investment, focusing on duration rather than percentage return.

• Operating Expense Ratio (OER):

  Evaluates the efficiency of property operations, focusing on operating expenses relative to income.