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rate of return on real estate investment

One of the great benefits of using the Real Estate Calculator is that it automatically calculates the Net Cash Out, as well as the resulting Rate of Return. All you or the client must do is plug in the numbers, and you’ll see how good your deal is. 

However, there’s a difference between seeing the results for yourself and verifying them through your own analysis. One of my favorite ways to demonstrate this in Truth Training is using the Rate Calculator. This simple calculator allows you to plug in variables that make it simpler to verify. This can aid your own understanding, as well as the client’s understanding, depending on your objectives. 

The trick, however, is inputting the correct numbers for the correct reasons. So we’re going to go through an example together. Let’s use the Real Estate Calculator tutorial that you can find right here, on the Truth Concepts website. 

NOTE: At the time of writing this post, we are using a newer version of Truth Concepts than in the video tutorial. This means that tax information has been updated, which will result in a slightly different ROR. The concept and process are still the same.

Inputting the Data

In the video, we analyze a real estate deal using the Real Estate Calculator, with data received from an advisor. You can see the details of the deal below. 

The highlights include:

  • $205,000 property
  • $160,000 mortgage
  • $45,000 down payment
  • 60 month rental period
  • Positive cash flow of $611/month

The result is an ROR of 24.88%. And while we can trust that the rate is accurate, verifying the math with the Rate Calculator can help us understand WHY. 

Calculating the Rate of Return

The rate of return that the Real Estate Calculator provides is an exact number, which takes into account all of the factors you plug into the calculator. It also uses the most current tax data. The Rate Calculator, on the other hand, is less exact. This is because the Rate Calculator only calculates level payments and numbers—it doesn’t take variable interest payments or taxes into account, for example. 

That’s why it’s important to remember that when we calculate the rate using a Rate Calculator, it’s not going to be exactly the same. It will, however, be in the same ballpark.

To get this calculation, you’ll first input the down payment into the Rate Calculator, which is $45,000. This can be considered the “initial investment.” Then, you’ll add the cash flow of $611. Put a (-) before the number to indicate that it’s not a payment, but instead a withdrawal. While you are not technically making a withdrawal, the calculator considers money flowing TOWARDS you (withdrawal) as positive cash flow. 

Then, you’ll add $80,686 as the Future Value. This number comes from the “NET CASH OUT” box. NET CASH OUT is simply the total future property value, net of any remaining loan balance, fees, and applicable taxes. 

Finally, if you haven’t yet, you’ll switch the payment frequency to monthly and input 60 months, which is the rental time frame. 

The result will be 24.79%, which is only a few decimal points shy of the exact ROR as calculated by the Real Estate Calculator. 

Explaining the Rate of Return

The Rate of Return is an essential calculation for any real estate deal so that you can properly analyze the metrics of the deal. This allows you to compare both real estate deals and other investments that come across your table.

As such, it’s important to understand how the calculation works. When you calculate the Rate of Return on a property, there are two important variables: the future value of the property, and the cash flow from the property. Both of these factors contribute to the rate of return. If, for example, your property never appreciates in value, you would still have an ROR greater than zero if you had positive monthly cash flow. This is also true if you never sell the property. By the same measure, you can still have an ROR greater than zero if the property value increases, but you have little to no cash flow from the property.

When you use the rate calculator to calculate the ROR, you’re factoring in both of these numbers. The Future Value represents the property value, net of the remaining loan balance and taxes. The monthly withdrawal is your cash flow.

When you’re working with your client, it may be helpful for you to use a Rate Calculator to help them understand how these numbers contribute to the ROR.

Learn How to Explain Difficult Financial Concepts

When you’ve been in the industry long enough, some concepts and calculations seem simple to you. However, things aren’t always as simple from the client’s perspective. Attending a Truth Training is a great way to refresh your knowledge and learn how to better explain and break down concepts your client might find difficult. You can sign up for our next Truth Training event here.