how do you calculate return on cost and is this the same as ROI…a quick example will be helpful
“Return on cost” is not an often used term in real estate investment but it harmonizes better with the definition of “Cash on Cash” rather than ROI. Let me give you a basic example:
Let’s say you buy a house for $100,000 and then turn around and sell it as is for $110,000.
Your ROI is 10% (10,000/100,000). ROI reports the return on the total investment including any bank loans.
If you paid 10% down (or $10,000) then your cash on cash return is 100%. (For the sake of simplicity we will not include closing costs.) This measures the return on the money you had to physically spend.
A true cash on cash return (or return on cost) should include all of the out of pocket monies spent on this investment including closing costs, mortgage interest, repairs, renovation, utilities, taxes, insurance, selling costs etc.
The return on investment formula:
ROI = (Gains from investment - Cost of investment)/Cost of investment
Gains from investment refers to the proceeds obtained from selling the investment of interest.
For example, a marketer compare two different products by dividing the gross profit that each product has generated by its respective marketing expenses. A financial analyst, however, may compare the same two products using an entirely different ROI calculation, perhaps by dividing the net income of an investment by the total value of all resources that have been employed to make and sell the product.
This flexibility has a downside, as ROI calculations can be easily manipulated to suit the user’s purposes.
Hey,
I like to use cash-on-cash return when evaluating real estate deals.
Here’s an example…
I’m buying a multi-family property that cost $300,000.00.
The lender requires 10% down, which equates to $30,000.00.
The pre-tax cash-flow on the property is $18,000.00 per year ($1500.00 per month).
$18,000/$30,000=60% cash on cash return or that you receive 60% of the initial
investment back in the first year.
If you’re a veteran like me, you can acquire deals (1-4 units) with no money down.
This gives me an infinite return.
Good luck!!
Good information!
Return on Cost is an accounting term more appropriate to a large company than to a rental activity. Return on Cost is really a cost-benefit ratio analysis, that tells you how efficiently existing resources are used to generate new income. In other words, how much income will be “returned” for each new dollar invested.
As a rental property landlord, you are not usually faced with these decisions. You don’t do a cost benefit analysis to decide whether to put on a new roof. You put on a new roof when you need one, even though you won’t be able to get more rent just because your property has a new roof.
Return on Investment to a rental property owner is more often a measure of the cash flow generated by the property divided by the cost of the property. Cash on cash return, is the ratio of cash flow to the total amount of cash out of pocket you invested in the property.