Wednesday, March 28, 2012

Calculating Your ROI in Investment Real Estate

Real estate has been in a major downtrend for the last 5 years.  While all real estate is local, it is safe to say that there was a real estate bubble that burst for the large majority of Americans.  The downtrend may continue for a little while longer, depending on how long it takes for the malinvestment to clear.  Mortgage rates are even harder to predict, as it depends on what happens with interest rates in general, which depends on the Federal Reserve's monetary policy and the overall state of the economy.

I have read and heard people say that now is a terrible time to invest in real estate.  Perhaps that means that we are beginning to see a bottom.  Perhaps not.  But now is not a terrible time to invest in real estate.  It was a terrible time 5 years ago.  In many places, housing prices are half of what they were back in 2006 or 2007.  With the loose monetary policy by the Fed and the potential for it to continue, it is easy to see a scenario where housing prices go up quite a bit from here, at least in nominal terms.

If you are in the right situation and you live in an area where housing prices are a good deal, I think now is an excellent time to start investing in real estate.  If you have some money in the bank and you plan to stay in your current area, then you may have a great opportunity.

So how do you know if you can get a good deal?  One easy way is to calculate the monthly expenses of a place (including mortgage, taxes, insurance, and potential repairs) and compare that to the potential rent.  If you can have a positive cash flow with the rent, then it is probably a good deal.

You should look for a place in a decent neighborhood.  You should look at 3 bedroom - 2 bathroom houses, and not more.  Condos and townhouses may be ok, but keep in mind that they will not appreciate as much and you will also have to include the association fees as a significant cost.

There are different ways to calculate your potential return on investment (ROI).  Here is how I like to do it.  Forget taking a mortgage (even if you may have to).  Let's say you can buy a place for $100,000.  Let's say that the taxes will be $100 per month.  Let's say there are association fees for $100 per month.  Let's say you can estimate repairs of $50 per month (just as an average estimate).  Let's say the insurance will be about $50 per month.  Your total expense are $300 per month.  Let's say you can rent the place out for $1,000 per month.  This will mean a net of $700 per month.  Again, this is without a mortgage.

In that scenario, you take the $700 and multiply it by 12 months.  You get $8,400 per year.  Take that number and divide it by the purchase price of $100,000.  You get 8.4%.  That is your ROI.  Your $100,000 investment will get you a return of 8.4% if your estimates are correct and you keep it rented.

To me, that seems like a decent return.  When you are considering an investment property, don't worry too much about appreciation.  That will be icing on the cake.  Just make sure to buy in a decent neighborhood where it is unlikely to lose nominal value over the long run.  Worry the most about your ROI.  If you are taking out a mortgage, you want to have positive cash flow.

Many Americans have been financially devastated from the housing bubble crash.  Many feel defeated.  Now is a great time for investors to take advantage of great deals.  You can be choosy and take your time.  If you see something you like and the numbers look good, you can build real wealth over time.

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