Understanding Return on Investment

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Real Estate

As an investor, it is important to know how to calculate cash flow. The formula is:

Net Operating Income (NOI) = Total Income - Total Operating Expenses

Total income would include rental income and any other applicable income such as laundry, parking amenities, etc. Operating expenses are considered as mortgage, utilities and any other property associated expenses.

The ROI measures the profitability of a real estate investment. In lamest terms, it is the measure of how much profit (or loss) an investment has experienced compared against the amount of the initial investment. While the exact amount to expect cannot be predetermined when preparing to purchase an asset, intelligent calculations can assist in helping investors make a calculated decision when preparing to purchase a property. There are varying factors considering potential ROI for investments, ranging from the type of investment to the maintenance and operations for the specific investment type. 

Capitalization Rate (Cap Rate) 
The capitalization rate is a tool used to evaluate the potential profitability and potential return on an investment. The higher the cap rate, the higher the potential return and risk, while the lower the cap rate, the lower the return and risk. Cap rate can be calculated using the following formula: Cap Rate = (Net Operating Income / Current Market Value) * 100

Cash-on-Cash Return (CoC)
Cash-on-cash return refers to the amount of cash generated compared to the initial cash investment. A higher CoC indicates that the investment property is a more favorable or more valuable asset. The formula to calculate the cash on cash return is: (Annual Pre-Tax Cash Flow / Total Cash Investment) * 100 

Gross Rent Multiplier (GRM)
The Gross Rent Multiplier allows investors to run a quick calculation of the potential profitability of an asset. It is a simple calculation that relates the property's market value to its rental income, helping investors assess the property's income-generating capacity relative to its cost.

The formula can be calculated using the following: GRM = Property Market Value / Gross Annual Rental Income

The GRM is a ratio that can help determine the desirability of an investment opportunity. A lower GRM typically indicates a property with a higher potential for return on investment, as its rental income outweighs its market value. However, it is important to remember that the GRM is just one factor to consider when evaluating real estate investments. It is crucial to conduct a comprehensive analysis of factors such as operating expenses, potential vacancies, and market conditions before making an investment decision.