In this article, we’ll review Return on Investment (ROI) and how financial returns are analyzed when investing in real estate.
ROI can be a confusing term for many real estate investors and those interested in investing in income producing property, otherwise commonly referred to as commercial real estate investment. What is a commercial real estate investment? It’s financial investment in those properties generally providing monthly income from ownership in multi-residential apartments, office buildings, industrial use, property, warehouse, strip retail centers or free standing retail. These properties generate monthly income that is used by the owner to pay down debt (mortgages) and all other monthly expenses such as property taxes and insurance and when done right, cash flow. The investment provides cash flow, principal pay down, and tax benefits for the investor.
The ROI is generally viewed as the annual or longer period financial benefit “return” provided from the investment in relation to the down payment and other costs needed to purchase the property. One should also consider the time involved to manage the asset. To determine ROI for any real estate investment, some facts and assumptions or “weighted” concerns, are made by the investor. For instance: what is a competitive (reasonably expected) gross annual income from the property, how much vacancy will the property experience annually, what will it cost to own the property, how will tax laws effect my investment and what type of appreciation may I expect given the timing and location of the investment?
To drill down further, it’s important to note the weighted concerns change based on timing, location and type of investment to name a few. For example: depending on the location and type of investment, a differing emphasis will be applied to the ROI formula appreciation expectations. For example, in an area like San Jose, CA an investor will heavily weight the ROI expectation with investment appreciation, but in rural America, annual cash flow from the investment will be more heavily weighted to determine ROI. The reason for this difference is simple, In San Jose, not many buildings (no land for new construction) can be added to the region…this forces those requiring a commercial facility to pay more to the existing property investor/landlord, driving property value higher. In Rural America, annual cash flow is more important because once property demand outstrips supply, generally, commercial property can be added to the region since land is available for new construction. However, new construction is not warranted until rents and ROI’s exceed costs associated with new construction. Cash flow is more important since new construction is available as an option going forward.
WRITER:Uncle Real Estate is a real estate broker in California. He is a real estate investor in California since 1989.