In this blog, I am going to explain what does Return on Investment mean, and what does Return on investment tell you about a potential property deal. This is one of the most important things you need to understand to be a successful property investor. It amazes me how I'm always meeting people who are in property, who don't know how to calculate Return on Investment.
What Is a ROI? (Return On Investment)
Otherwise known as ROI, Return on Investment is a comparison of how much you make from a property compared to how much you put in to generate that profit.
As successful property investors we should only ever buy a property that makes us positive cash flow (profit) every single month. If it doesn't make money, it's not an investment. It's a speculation because we hope the value will go up.
In Property Magic, I talk about the Five Golden Rules of property investing. Golden Rule Number Three is we only ever buy property that makes us positive cash flow.
So assuming that's the case, we look at how much money it makes us every single month. We then see how much it makes every year and divide that by the initial investment. This gives us a number we then multiply by 100 to give us a percentage. The higher the ROI, the better the deal.
If You Are Doing A Buy-To-Let Property
If you're doing Buy-to-Let investment properties, a ROI on a typical Buy-to-Let around the country might be between 5% and 7%. If you're in London, it's going to be maybe 2% to 3% because the prices are so much higher. But there's certain strategies you can use, such as Houses of Multiple Occupation.
That's where you take a house, you rent out individual rooms to people, and have a separate contract for each tenant. You get a much higher profit and a much higher Return on Investment. So a HMO should be 15% or more Return on Investment. This is why HMO's are such a profitable strategy because you get much more cash flow and a much higher Return on Investment.
“ROI measures how much money you’re getting back compared to how much you put in”
So the way you'd use this is you might find two properties. On the face of it, they look quite similar, similar rental values, similar purchase price, modelled exactly the same.
You can work out the ROI to see which of these is the best property. Now people often get confused with ROI and yield. An estate agent might talk about a rental yield and they're looking at what the gross rent is compared to the value of the property.
“In Property Magic, I talk about the Five Golden Rules of property investing. Rule Number Three is we only ever buy property that makes us positive cash flow.”
Whilst this comparison is interesting, it's not as useful as ROI because it doesn't take any of the costs into account. ROI measures how much money you're getting back compared to how much you put in. That’s why it is the most important thing you need to understand to be a successful property investor.
Make sure you understand what ROI is and why it is important and how to calculate Return on Investment. I hope this has helped explain this concept of Return on Investment.
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