How to Find Your Return on Investment (ROI) in Real Estate

The cost method and the out-of-pocket method are two important ways to calculate Return on investment (ROI), a measurement of how much money, or profit, you have earned on real estate investments as a percentage of its total cost.

2 Ways to Calculate Your Return on Investment (ROI)

There are two primary methods for calculating ROI: the cost method and the out-of-pocket method. Following are simplified examples of each method. Note that neither example accounts for any rental income your property might produce or any ongoing costs, such as property taxes.

The Cost Method 

The cost method calculates ROI by dividing the investment gain in a property by that property's initial costs.

As an example, assume you bought a property for $100,000 in all cash. After repairs and improvements, which cost you an additional $50,000, the property is valued at $200,000.

This makes your gain in the property $50,000 (i.e., $100,00 gain in market value less $50,000 spent on costs).

To use the cost method, divide the gain by all the costs related to the purchase, repairs, and rehabilitation of the property.

Your ROI, in this instance, is:

$50,000 ÷ $150,000 = 0.33, or 33%.

The Out-of-Pocket Method 

The out-of-pocket method is preferred by many real estate investors because it results in a higher ROI. It takes the current equity of the home divided by the current market value. Note that this differs from the above calculation where the cost method divides the investment gain (not the equity) by the initial total costs (not the market value).

Using the numbers from the example above, assume you bought the same property for the same price, but this time, you financed the purchase with a loan and a down payment of $20,000.

Your out-of-pocket expense is $20,000 plus the $50,000 for repairs and rehab, for a total of $70,000. With the value of the property at $200,000, your equity position, or potential profit, is $130,000.

Your ROI in this case is:

$130,000 ÷ $200,000 = 0.65, or 65%.

This is almost double the first example's ROI. The difference, of course, is attributable to the loan: leverage as a means of increasing ROI. 

What Is a Good Return on Investment for Real Estate Investors?

What one investor considers a "good" ROI may be unacceptable to another. A good ROI on real estate varies by risk tolerance—the more risk you're willing to take, the higher ROI you might expect. Conversely, risk-averse investors may happily settle for lower ROIs in exchange for more certainty.

In general, however, to make real estate investing worthwhile, many investors aim for returns that match or exceed the average returns on a major stock market index such as the S&P 500. Historically, the average annual return on the S&P 500 is about 10%.

Of course, you don't have to buy physical property to invest in real estate. Real estate investment trusts (REITs) trade like stocks on an exchange, and they can provide diversification without the need to own and manage any property. In general, REIT returns are more volatile than physical property (they trade on an exchange, after all). Equity REITs delivered five and 10-year compound annual returns of 3.45% and 6.59%, respectively, for the period ending March 31, 2024, as measured by the FTSE Nareit All Equity REITs index. You can also invest in REITs through mutual funds that specialize in them.

Costs That Can Reduce Your Return on Investment

In order to realize your ROI in actual cash profits, you have to sell the property. Often, a property will not sell at its market value, which will reduce your expected ROI if that was the number you based your calculations on.

In addition, there are costs associated with selling real estate, such as repairs, painting, and landscaping. The cost of advertising the property should also be added in, along with appraisal costs and the commission to any real estate agent or broker that's involved. And, of course, if there's a mortgage on the property it must be paid off.

The Bottom Line

Calculating your ROI is a way to determine how much profit (if any) you have made on a real estate investment. You can also use it to compare the return on real estate to other potential investments, such as stocks. The examples above are simplified for the purposes of illustration, and, depending on all of the costs involved and any potential cash flow you receive from your real estate investment, getting a precise ROI may be more complicated. For tax purposes, in particular, you will most likely want to consult an accountant or other tax professional who is familiar with the rules as they apply to real estate.