Return on Investment (ROI) in commercial real estate is the measurement of how much money a commercial real estate investor will receive after the deduction of all the expenses incurred. The general formula for calculating ROI is:
ROI = (Investment Gain – Investment Cost)/Cost of Investment
ROI is a key driver in investment decisions in commercial properties for many investors. To achieve ROI, everything trickles down to the identification of investment opportunities, performing due diligence and find comfort in some level of risk. Find properties that can suit your budget spectrum.
Factors that may affect your return on investment in commercial real estate
Even though commercial properties are more inclined to make more compared to residential properties, there are some few factors fundamental factors that will affect the ROI of your commercial property:
- Expenses: It is important to consider the fixed and variable costs incurred while calculating your ROI. Fixed costs include taxes, expenses, stamp duty or insurance costs and variable costs may include general repairs and maintenance.
- Tax obligations: There are some underlying tax obligations like capital gains tax, tax deductions and gearing that can affect your ROI. For instance, if you sell your property, you will have to pay capital gains tax or gearing, which occurs when you get higher rental return against expenses. A positive gearing does not favour capital growth.
- Risk: The greatest risk is vacancy. Higher vacancy rates will lower your yields by a great margin. Although it is near impossible to control vacancy rates, you can make a step to cushion yourself from this risk by securing long-term tenants.
- Yield: You can tell the percentage rate of return of your property’s market value but the calculation of net yield is a more accurate way you can determine yield and it can help you decide on whether to invest on a property or not. Commercial properties come with greater yields that translate to greater profits but the risks too are greater.
Complications in calculating Commercial real estate ROI
Some complications might arise when calculating for ROI for your commercial properties. Some of the complications you are likely to encounter are in the property you own was refinanced or there was a second mortgage take out. This is so because the interest rates that are liable to be charged on the refinancing or mortgaging will increase and loan fees charged. These factors will significantly reduce your ROI. Apart from refinancing and second mortgage take out, there are other issues like arising maintenance and repair costs, utility rate and tax obligations and all them need to be considered in the calculation of ROI.
Furthermore, it is possible that you are going to experience some complex ROI calculations if you acquired the property with adjustable-rate mortgage with a variable rate that is charged per-annum throughout the life of the loan.
2 primary methods to calculate ROI
There are two primary methods you can employ to calculate your ROI and they are:
- The cost method: This is where you calculate your return on investment by dividing your equity in the property by all the property’s costs.
- The out-of-pocket method: This is the most preferred method of calculating commercial real estate ROI because it has a tendency of giving higher ROI results where a property owner has the chance to utilising leverage as a way of increasing the property’s ROI.
Scenarios that increase your commercial property’s ROI
The combination of a long-term high-profile tenant with term that are favourable. Some of the terms could state that the tenant is liable to the tenant paying any outgoings and incorporating a clause on fixed annual rent increases. This can earn you above-average returns.
Looking beyond your scope of sight like doing your due diligence on regional areas rather than metropolitan areas. Properties like retail or medical premises have the ability to perform as good as those in metropolitan areas but you could, however, acquire them for considerably less.
Utilise property data to further explore the market. Finding and exploring property data and having them at your fingertips accord you good chance of property investment decisions. You will know when to invest, where to invest, how much you are willing to invest and the size of the property.