Investing your hard-earned income is the key to accumulating wealth in the long run! While investing in a business can be fruitful, it usually has risks tied to it. Investing in commercial real estate shows great promise in this aspect as you can potentially earn while being a passive investor.
Here is where calculating your return on investment (ROI) becomes an important metric to judge whether an investment is good or bad.
Calculating ROI on commercial property can give you an idea of your financial gains and risks. However, for beginners, it can get a little overwhelming. So, today we will be breaking down the steps on how you can calculate ROI.
Once you understand what is happening at each step you will be able to get a good understanding of how to grow your returns on investments. Let’s get started!
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Net Operating Income
Net Operating income is a metric that calculates your total income from properties after deducting operating expenses before tax. Rental Income from your commercial properties is the income in this case.
The Formula is:
NOI = Rental Income – Operating Expenses
Return on Investment
Once you have found your NOI you can proceed to calculate your ROI.
The formula is:
ROI = (NOI / Total Investment Made) x 100%
ROI in Commercial Real Estate: Explained In Detail
Average Return On Commercial Real Estate
A real estate asset’s average return on investment (ROI) states its profit or loss over time. There are several ways to compute this.
Investing in commercial real estate requires going through a plethora of variables. Properties need to be maintained and the state of the market and the behavior of the tenants affect their value.
When you’re finding the average return on investment, you get to evaluate your investment opportunities and get a good understanding of your potential returns. Once you understand this metric you can make proper decisions on how to invest in your commercial real estate, be it expand, sell, or renovate.
What Is A Good ROI In Real Estate?
A “good” return on investment is a very subjective term. What may be good for one can be the opposite for another.
Generally, according to market indices, investors try to aim to get a return between 8 to 12%. Your real estate’s property type, market conditions, and investment objectives can positively affect your Return on Investment.
According to the S&P 500, the median annual return in the US is 8.6%. Residential properties average 10.6%, commercial properties 9.5%, and REITs 11.8% in return on investment, depending on the strategy used.
How To Calculate ROI On Commercial Property? (Step-by-step Guide)
Here is a step-by-step guide on how to properly calculate your commercial real estate’s Return On Investment.
What is Your NOI?
When calculating ROI you need to first calculate your property’s net operating income (NOI). To get the NOI, subtract operating expenses from the property’s gross income.
The gross income can come in the form of rental income too. Operating expenses typically include taxes, maintenance costs, fees for property managers, and so on
NOI = Rental/Gross Income – Operating Expenses
How Much Is Your Property Worth?
After getting your NOI, you can then figure out exactly how much your property is worth in the current market. This is usually done through companies that specialize in this sector. You can find many property appraisal service providers to get this done.
Alternatively, you can also do this yourself by analyzing recent sales data of properties similar to yours in the area. The value of your property includes the value of the land your building sits on, any investment you made to improve your building, and anything that adds value to the property.
What is Your Cap Rate?
You need to calculate your cap rate to assessing the potential return on investment in real estate. To do this, divide the NOI you previously got by the property’s current value. To put it another way, the capitalization rate is a return metric that is used to calculate the payback of capital or potential return on investment.
Capitalization Rate = NOI / Property’s Current Market Value
Return On Investment
With both the NOI and cap rate at hand, divide the NOI by the total investment to get your ROI. The total investment is made up of the cost of your property when you first bought it and any additional expenses like extensions or extra floors.
ROI = (NOI / Actual price of Purchase) x 100%
Real-World Scenario
Let us now put all of the above into a real-world scenario. Say you have a commercial property worth $1,200,000 and your Net Operating Income is $150,000
Using the ROI formula: ROI = ($150,000 / $1,200,000) x 100% = 12.5%
Thus your property generates a 12.5% return on your investment annually indicating that it is performing well by 3% better than the commercial property industry’s median value.
Frequently Asked Questions
How To Calculate ROI On Rental Property?
Similar to calculating ROI on commercial property, to calculate ROI on rental property, you need to find out the property’s NOI by subtracting operating expenses from rental income. Then put it in the formula divide the NOI by the total investment (including purchase price and any other expenses) and multiply by 100.
How To Calculate Profit On Property Sale?
To calculate profit on property sales, subtract the original purchase price and any acquisition costs from the sale price. Then deduct selling expenses, such as sales commissions for any agents and closing costs. The remaining amount is your profit from the property sale.
Invest In Commercial Properties With Proper ROI Calculation
Understanding your average return on investment is necessary for you to make informed decisions on your property. Once you get a grasp of it, you can ensure long-term success in the commercial real estate market.
Continuously evaluate investments, adapt strategies, and seek the perfect opportunities to maximize returns as your portfolio expands. If needed you can even link up with professional real estate managers like RSN Property Group. We can help you with consistent property assessment and actively navigate you in this dynamic market of commercial real estate.
