Before purchasing any real estate property, you’ll want to become familiar with how to calculate estimated profit. You’ll want to know if it’s a good investment, meaning you’ll get a good return on your investment (ROI).
You’ll be able to earn a profit by cash flow and appreciation on the home. These numbers will be the main components when using ROI calculations. Positive cash flow is the goal, while at the same time earning some appreciation as the home goes up in value.
Calculating estimated profit comes down to crunching numbers, so you’ve got to know what numbers to use. Also, the guidelines that you use can vary depending on what the real estate market is doing.
Let’s look at an example so you can see how to work through some of the numbers.
Essentially, you’re calculating Income and Expenses, but let’s break it down a bit.
Say you’re looking at purchasing a home with cash at $100,000. This is the Sales Price.
Now, figure out the estimated Monthly Income, which usually is the monthly rent payment.
Now, calculate the Monthly Expenses, including:
- Insurance
- Property taxes
- HOA fee (if applicable)
- Estimated Repair Value
- Vacancy rate
Now, you’re going to calculate Net Income as such:
Net Income = Monthly Rent – Monthly Expenses
Cash-on-Cash Return
Cash-on-Cash Return is what you want to figure out to see if the property will be worth the investment. Now, considering we’re paying cash for the investment, this number is going to be just like the Cap Rate. To calculate Cash-on-Cash Return, use this formula:
Cash-on-Cash Return = Net Annual Income divided by Cash Invested
Using the example above, let’s run some of these numbers:
- Purchase Price – $100,000
- Cash to close – $22,500
- Monthly rent – $1,300
EXPENSES:
- Property tax – $125
- Insurance – $85
- Repairs (5%) – $65
- Vacancy (10%) – $130
- HOA – $490
- Total = $895
INCOME – EXPENSES: $1300 – $895 = $405 (This is monthly cash flow)
CASH-ON-CASH RETURN: Annual Net Income divided by Cash Invested
- $405 x 12 = $4,860 (Monthly cash flow times 12 months)
- $22,500 (Cash invested)
- Cash-on-Cash Return = $4,860/$22,500 = 21.6% (This is a great ROI!)
Granted, these are simply estimates just to get an idea of what estimated profit or ROI could be. There are always other things to consider, and the reality is that the figures could turn out to be different than expected after you buy the property. However, to maybe get a ballpark estimate, you can use a formula like this, and the more you’re in the property investing business, the better you get at estimating. It’s just the nature of practicing because as you practice, you get better!
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