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What Is Return On Investment And Which Is The Best Way To Invest In Real Estate
I recently met up with a friend for dinner and the topic of real estate came up. He just turned 38 and was thinking it might be time to buy a place. He would rather live in a high rise in the heart of downtown, but wanted to buy something as an investment. He didn't didn't know the different options available to him. I explained it to him, but he wasn't able to grasp the concept. So I sent him an email breaking down the 2 most common types of residential real estate investments. I thought this might be a question that other may have, so I'm sharing with you today what I shared with him.
Below is a break down of the definition of Return on Investment (ROI) and the 2 different types of residential investments.
Return on investment (ROI) measures the gain or loss of an investment relative to the amount of money invested. ROI is usually expressed as a percentage and is typically used for personal financial decisions, to compare a company's profitability or to compare the efficiency of different investments. The ROI calculation is flexible and can be manipulated for different uses.
The return on investment formula is:
ROI = (Net Profit / Cost of Investment) x 100
For example, an investor buys $
2,000 worth of stocks and sells the shares two years later for $ 2, 400. The net profit from the investment would be $ 400 and the ROI would be calculated as follows:
ROI = (400 / 2,000) x 100 = 20%
The ROI in the example above would be 20%. The calculation can be altered by deducting taxes and fees to get a more accurate picture of the total ROI.
The same calculation can be used to calculate the return on real estate. However, the calculation is more complex because you need to subtract taxes, insurance, and other expenses from the profit then divide it by the amount paid for the property. This calculation doesn’t factor in appreciation of a property over time.
Real estate investments can produce ROIs of 8-18%. This depends on if you’re paying cash, getting financing, the purchase price, interest rate, expenses and rental price and rate. Depending on whether or not your investments are aggressive or not, 401ks don’t typically produce that high of a return in recent markets. Also, if the market tanks, you may lose with your 401k. However, with real estate, if the value goes down, the rental rates remain in a place that is profitable. Real estate values are cyclical. They usually rise and fall every 7 years, but slowly gain value over time. Of course development can drastically affect this.
There are 2 types of residential investments. You can purchase a property for long-term rental or short-term rental.
A short-term rental, or vacation rental, is when you rent out a home nightly, weekly, or monthly to snow birds or vacationers. The home can be reserved for your own use at anytime. Think of it like the legal antiquated version of airbnb. The homes need to be in a short-term rental approved community.
There are peak season and slow seasons. Typically peak seasons are during holidays or anytime kids are out of school. During this time demand is high, so higher rates are charged. These types of properties can be mostly found in the Kissimmee and Davenport areas. The main attractions are the Florida weather, Universal Studios, Disney and other near by attractions. You may also get the convention or events crowds. Vacation rentals are popular because they can be less expensive than hotels, with the added benefit of a kitchen, more space, and more privacy.
Short-Term Rental Pros and Cons
Though there are peaks and lulls, a short-term rental might produce more income over the course of the year because higher rates are charged around holidays and popular travel times. There are also tax breaks for short-term rentals in terms of not having to report certain rental income to the IRS and also the opportunity to deduct property-related costs like advertising or operating. For example, the property needs to be furnished and you pay for all utilities.
Because the home isn’t occupied 365 days a year, there may be less wear on the property. If you have a good property manager, your vacation home should be kept in great condition because they are able to do proper maintenance between guest stays.
With long-term rentals, the owner of the property rents out their home on a long-term basis, receiving rent payments monthly. The usual time frame is a 1-2 years. This market can be found in anywhere in the Central Florida market.
Long-Term Rental Pros and Cons
The primary benefit to long-term is owners receive consistent rent payments monthly. There is also no need for the property to be furnished and no monthly utility costs.
The cons are renters can be late on payments or become squatters. Also, there is less opportunity to keep the property maintained.
If you have more questions about this anything related to Real Estate. Please contact me and I would be happy to help!
Jen is a seasoned Real Estate Agent with more than 7 years of experience in the industry. She started out as a Title Insurance Marketer in Park City, UT, then moved to Florida to enjoy the beautiful ....