Making an investment in real estate means approaching – often for the first time – a whole set of financial rules governing this type of economic transaction.
Knowing them can make the difference between a good deal and a complete failure, especially in view of the fact that many – too many – real estate brokers base their communication on hypothetical “magic formulas” capable of guaranteeing significant economic returns effortlessly and in a short time.
It goes without saying that there is no magic formula for generating automatic returns, and that in-depth knowledge of the financial world is important for both the investor and the intermediary.
The Remida Properties team has a very specific policy in this regard, which is based on sharing and having an in-depth knowledge of potential real estate investments. So, if you decide to tackle this sector for the first time, it will be good to clarify some fundamental aspects, such as the meaning of ROI (return on investment) and other typical terms that you will hear very often during a real estate transaction.
What is ROI, what is the formula to calculate it and how is it used?
ROI, or Return Of Investment, is a very important percentage indicator for analysing the value of any investment made or about to be made.
In a nutshell, ROI shows us in percentage terms the positive return (and thus profit) or negative return (and thus deficit) obtained as a result of a specific investment.
The chosen formula for calculating ROI is: Net profit (revenue – invested capital) / invested capital x 100.
Let’s take a practical example: let’s imagine that we are acquiring a property for € 100,000, to which we will add € 50,000 for renovation and € 10,000 for bureaucratic expenses.
The sum of these factors therefore results in an invested capital of € 160,000 in total, which for convenience we will take as a basis, in the absence of other expenses.
Let’s imagine that we resell the property, for example in a renovation and sale operation called property flipping, for a figure of € 200,000. This means that the profit (200,000 – 160,000) will be € 40,000. Dividing this sum by the capital invested (€ 160,000) and multiplying by 100 to obtain a percentage, we will then find that the ROI of this investment is
40,000 / 160,000 X 100 = 25% (Return of Investment)
ROI breakdown (ROS and ROT)
The return on investment can in turn be broken down into two equally important indicators, ROS (Return on Sales) and ROT, which unlike ROI and ROT is not a percentage indicator but shows the turnover rate of the invested capital.
ROS basically shows the performance of a transaction in percentage terms, thus establishing the capacity (especially when compared to different investments) of a range of transactions to generate income.
In an investment property, the ROS is calculated by dividing the operating income by the revenue, and then multiplying the result by 100.
Let’s go back to the previous example, for which we know that the operating income (profit) is € 40,000. We also discovered that the income from the sale of real estate was € 200,000.
This means that by applying the above formula
40,000 / 200,000 X 100
We will find that the ROS of the real estate operation is 20%.
Now, the ROT, i.e. the turnover rate of the invested capital, shows us through a numerical indicator, how many “times” the invested capital has been transformed into revenue.
If, for example, an investment property of € 100,000 generated revenue of € 150,000, this means that the ROT (sales revenue / invested capital) is 1.5.
WANT TO KNOW MORE? THERE’S A GIFT FOR YOU.
ROI, ROS and ROT, are just a few of the key parameters to evaluate in a real estate transaction.
Which type of real estate transaction best suits your needs, your time frame and your budget? Flipping Real Estate, Property Rental, Wholesaling or Apartment Building?
What elements do you need to take into account when buying a property in order to make a profit?
Is it possible to operate as an individual or is it necessary to set up a company in the USA?
And what about taxation of profits, what are all the steps to be followed to be fully compliant?
We explain this and much more in the “INTRODUCTORY COURSE IN THE US REAL ESTATE MARKET”.
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