Real estate investments can be lucrative, especially if you are purchasing properties with significant upside. Measuring how much you make can be challenging, though, since investing in property has a number of different models for valuing your return. Ultimately, there are three key metrics that will help you understand quick-flip investments, long-term cashflow plays, and combined investments that span both increasing value and collecting longer-term cashflow.
The Total Return
For real estate investment projects where you plan to be in and out quickly, the best metric is your total return. Add up everything you spend to acquire and rehab the project, including your down payment, loan fees, carrying costs and construction costs. Subtract those costs from your projected net proceeds at sale, after paying commission, closing costs and paying off your loan. The result is your cash return. Dividing it by your cost gives you your total return as a percentage of costs.
The Cap Rate
Real estate investment analysts use capitalization rates to compare cashflowing properties on an unleveraged basis. To calculate a cap rate, divide a property's net operating income by its purchase price or market value. You can then use these cap rates to compare the returns from different properties.
Internal rates of return are one of the most powerful real estate investment analysis tools available. They look at every aspect of the ownership of property and express the totality of them as an annualized rate of return. While you can use specialized software to do complicated IRR models, you can also run a simple analysis with a spreadsheet.
To calculate an IRR in a spreadsheet, you start with a negative number that represents your initial investment, and then add a number that represents your annual cashflow for each year. In the last year, make sure to include your sale proceeds with your cashflows. You then use your spreadsheet's IRR function to calculate. For instance, if you buy a fixer-upper for $150,000 cash and spend $50,000 on it, your year zero entry would be -200,000. If you get $1,800 a month in rent and have $800 a month in taxes and insurance, you'd have annual income of $12,000. If, at the end of five years, you sell it for $281,000 after commission and closing costs, you'd have an IRR of around 12 percent, meaning that you earned the equivalent of 12 percent a year on your initial $200,000 investment.