Calculating the returns on investment properties in Sri Lanka
With the real estate market booming at the moment, there are plenty of properties for sale in Sri Lanka. However, before you invest in a rental property, you should make sure that you will find a sustainable return for your investment. The ROI formula (Return on Investment) is a widely used measure which can help you out on this regard.
ROI Formula
You could calculate your ROI by multiplying your potential monthly rental by 12 and then dividing it by the cost of investment. Multiply the number you get to find out the percentage of your ROI.
ROI = Net Income / Cost of Investment x 100
It is a good idea to calculate the ROI of multiple properties before you make a decision. In spite of its simplicity, the ROI formula is versatile and you can use it to figure out return from investment in different properties.
Limitations
There are limitations to the ROI formula. The method does not adjust to the level of risk which can have a significant impact on the returns. The other problem is that if you are obtaining a loan to finance the investment, you will have to include the interest rate in your calculations to get a realistic figure. You should also take into account other costs such as maintenance cost to get a near accurate figure about returns.
Alternate ROI methods
There are alternate (more complicated) ROI methods you could use if the simpler ROI method does not work for you.
The Cap Rate formula
The Cap Rate formula can measure the property?s return on investment for a year. You can get the cap rate by dividing the Net Operating Income by current value of the property and then multiply it by 100.
Cap rate = Net operating income/current property value x 100
Cash on cash return
This method is generally used by those who obtain a mortgage to buy properties. You should follow the below steps to calculate the cash on cash return.
Cash on cash return = Annual pre ? tax cash flow / Total cash invested x 100
- Annual pre-tax cash flow = Gross rental income + Additional income derived from the property ? mortgage interest rate ? operating expenditures
- Total cash invested = Down payment + closing cost + refurbishing costs
- Divide the annual pre-tax cash flow by total cash invested and multiply this by 100 to calculate the ROI.
