Real estate investing is high stakes. This is because real estate isn’t cheap! You’re spending thousands and millions of dollars on real estate deals. To be successful, you have to make smart, profitable decisions. This is especially true when dealing with off-market properties, where unique opportunities often come with unique variables. It’s a thrill to find a diamond in the rough, which is an undeniable win in terms of profit. The only way to know you’re heading in the right direction and you’ve secured a win is to understand return on investment (ROI).
Many new investors rely on simply math to calculate returns, which leaves them with surprises in the end. True ROI calculation goes beyond just the purchase and sales price of the property. It benefits investors to track each dollar spent by the property and each dollar the property brings in. Let's break down how to calculate ROI like a seasoned pro, ensuring your off-market deals live up to their potential.
Beyond the Basics: What a Real ROI Calculation Includes
At its simplest, the ROI formula is straightforward:
ROI = (Net Profit / Total Investment Cost) × 100%
Where:
The devil, as they say, is in the details. So this means you want to keep an eye on the "All Other Associated Costs" part. This is where many investors can make mistakes. Your total investment cost isn't just the price you paid for the property, which should include all inspections. A complete view for off-market deals, includes acquisition, holding, renovation, and selling costs. According to market analysis from firms like ATTOM Data Solutions, which frequently reports on flipping profitability, overlooking these seemingly small expenses is a primary reason why projected profits aren’t maximized.
Tallying Your Full Acquisition Costs
Securing an off-market property involves more than just the price you pay for it, especially if you’re buying the home with a loan. Your initial investment basis must include these crucial expenses:
Forgetting these upfront costs immediately skews your ROI calculation, making an investment appear more profitable than it truly is. Keeping in mind, you’ll need enough return to account for any potential issues that may arise with the property or to return funds to those backing your deal.
The Critical Role of Renovation & Repair Costs
Your strategy will play a main role in renovation and repair costs. If you plan to develop property, then you’ll have simple construction costs. If value add is your strategy, then renovation and repair costs will be essential to your calculation, which includes your ability to predict after repair value (ARV). For off-market properties, especially distressed ones, the renovation budget is your biggest variable and greatest risk. Really sit down and come up with an estimate for your upgrades, and if you don’t, it is a recipe for disaster.
Your total renovation cost is the sum of all contracted work plus your contingency fund.
Don't Forget Holding Costs: The Silent Profit Killer
Holding costs are the expenses you incur for every day you own the property before selling or renting it. The longer you hold it, the more these costs eat into your profits. The typical length of time for holding a flip, for example, would be 3 to 6 months. You also want to consider how long your property may sit on the market based on average days of your area. Some of the costs you need to consider:
Miscalculating your project timeline by even a few months can add thousands in holding costs, drastically reducing your final ROI.
Accounting for Selling Costs
Once the property is renovated, you need to sell it. It’s recommended to get a good real estate agent to help you list your property. Homes typically sell for $58,000 more on average when it’s listed by a relator, according to the National Association of REALTORS (NAR). While this helps to off-set costs, you still need to know costs to sell. These costs are significant and must be factored into your initial analysis.
Failing to subtract these from your projected sale price will give you an inflated sense of your potential profit.
Putting It All Together: An Off-Market ROI Example
Let's run the numbers on a hypothetical flip:
Total Investment Cost: $150k + $5k + $40k + $6k + $9k + $18k = $228,000
You project the After Repair Value (ARV) and sell the property for $270,000.
Net Profit: $270,000 (Sale Price) - $228,000 (Total Cost) = $42,000
Now, calculate the true ROI:
ROI=($228,000 / $42,000) × 100% = 18.4%
ROI vs. Cash-on-Cash Return: Know the Difference
It's crucial to distinguish ROI from other metrics. Cash-on-Cash Return (CoC) is particularly important if you use financing. It measures the return on the actual cash you invested.
Using the example above, let's say you used a hard money loan and your actual out-of-pocket cash for the down payment, closing costs, and renovations was $60,000. A hard money loan is a short term loan with a high interest rate that gives you money to make updates to a home to do a cash out refinance or flip to quickly pay back the loan.
Cash-on-Cash Return=(Total Cash Invested)/(Net Profit)×100%
CoC Return= ($60,000 / $42,000) × 100% = 70%
Both metrics are vital. ROI gives you the overall profitability of the project, while CoC Return shows you the cash income returned based on the cash you invested into the property. Some investors will decide to follow one or both of these metrics depending on their goals. For example, you may have a lower ROI with high CoC, like on lower valued property, and that’s perfectly okay!
Your Blueprint for Profitability
Knowing how to calculate ROI, use an ROI calculator, or use tools that calculate ROI for you allows you to make better decisions. Accounting for all of your expenses, income, and every little detail can feel cumbersome. Using accounting trackers like Quickbooks or Freshbooks can really help you to keep track of everything. Make sure to stay informed so you can make good decisions, negotiate better, and confidently find off-market deals that build your wealth and help you retire with passive income. Don’t estimate your earnings, calculate them.
Frequently Asked Questions (FAQs)
How can I accurately estimate repair costs for an off-market property I haven't inspected yet? Use a tiered approach. Create best-case, worst-case, and most-likely budgets. You can use general per-square-foot estimates (e.g., $15-$25/sqft for a light cosmetic rehab, $40-$60+/sqft for a gut job) as a starting point, but always refine this with a contractor's walkthrough before closing.
What is a "good" ROI for a flip? This varies by market, risk level, and project timeline. However, many investors won't touch a flip with a projected ROI of less than 15-20% due to the inherent risks and unforeseen costs. A lower ROI might be acceptable on a quick, simple project, while a more complex renovation demands a higher potential return.
How does financing impact my ROI calculation? Financing adds complexity. The costs of the loan (origination fees, points) are added to your Total Investment Cost. The monthly loan payments are a major part of your holding costs. While financing reduces your out-of-pocket cash (boosting Cash-on-Cash Return), it increases your overall project costs, which can lower your total ROI.
Should I include the cost of my own labor ("sweat equity") in the ROI calculation? For a true and scalable business calculation, yes. You should assign a fair market value to your time and labor and include it in the renovation costs. If you were not doing the work, you would have to pay someone else. This practice helps you understand if a project is truly profitable and allows you to accurately compare it against deals where you hire out all the work.
Is a high ROI always the most important factor? Not necessarily. A project might have a massive 50% ROI but take two years to complete. Another might have a 15% ROI but take only three months. You must also consider the Annualized ROI, which gives you a clearer picture of your return relative to time. A lower ROI achieved multiple times a year can often be more profitable than a single high-ROI project that takes a long time.