Calculating the return on investment (ROI) for commercial real estate involves understanding the income the property generates, the costs associated with purchasing and maintaining it, and the property’s growth in value. Here’s a basic formula to calculate ROI:
To break it down further:
- Determine Gross Rental Income: Calculate the total rental income the property will generate over a specific period, such as annually.
- Calculate Net Operating Income (NOI): Subtract operating expenses (maintenance, property management fees, taxes, insurance, etc.) from your gross rental income. Do not include mortgage payments in operating expenses.
NOI = Gross Rental Income − Operating Expenses
- Total Investment Cost: This includes the purchase price of the property, closing costs, renovation expenses, and any other initial costs to make the property rentable.
- Calculate Net Profit: If selling the property, your net profit is the sale price minus the total investment cost and any selling expenses. If holding the property, use the NOI to represent annual profit.
- Calculate ROI: Divide the net profit by the total investment cost, then multiply by 100 to get a percentage.
ROI = Net Profit / Total Investment Cost x 100
Example:
- Purchase price: $500,000
- Renovation and other initial costs: $50,000
- Total Investment Cost: $550,000
- Annual Gross Rental Income: $100,000
- Annual Operating Expenses: $30,000
- NOI: $70,000
Assuming the property is held and not sold, using NOI as the annual net profit:
ROI = $70,000 / $550,000} * 100 = 12.73%
This simple ROI calculation provides a snapshot of the investment’s performance but doesn’t account for factors like financing costs, tax implications, and property value appreciation over time. For a more comprehensive analysis, consider methods like the Cap Rate, Cash on Cash Return, or Internal Rate of Return (IRR), which can provide deeper insights into the investment’s profitability over time.