Return on Investment Calculation
Frequently you will see income and expense statements that do not include “vacancy & bad debt”, “maintenance”, or “management” costs. Here is a simple and effective way to ensure accuracy.
Start with G.O.I. “Gross Operating Income”
Less Vacancy and Bad Debts (calculate 2% – 4%)
Equals “Effective Gross Income” (you now have the true income & a starting point)
Next deduct expenses. For those missing expenses plan approximately:
- Management = 4% to 8% (The 4% manager may be the most expensive!)
- Maintenance = 2% to 5% (dependent on age and condition of property)
Deduct all other expenses to arrive at the N.O.I. or “Net Operating Income”.
Deduct A.D.S ‘Annual Debt Service” (the mortgage, principal & interest)
Result is “Annual Cash Flow”
To determine your R.O.I. “Return On Investment”, divide the cash flow by your investment (down payment + incidentals) For example if your annual cash flow is $4,000 and you have $50,000 invested, then you are making an 8% return on your money.
In an Agreement of Purchase and Sale (and among many other prudent measures) obtain from the Seller, proof of income statements (copies of leases, etc.) and copies of expenses (utility bills, tax statement, etc.) to ensure the accuracy of your R.O.I.
See an example calculation of cash flow and return on investment on the next page. It assumes a five plex apartment building sold for $600,000 with the Buyer using a $150,000 down payment (25%) to avoid paying a CMHC insurance charge.
Example Of Cash Flow Calculation
|Annual rental income||$70,000|
|Less vacancy & bad debt (4%)||$2,800|
|Effective rental income||$67,200||$67,200|
|Income from parking||$2,600|
|Income from laundry||$2,100|
|Total “other” income||$4,700||$4,700|
|Gross operating income (GOI)||$71,900|
|Total Operating Expenses (TOE)||$67,200||$67,200|
|Net Operating Income (GOI – TOE)||$71,900|
|Less Annual Debt Service|
(Mortgage Of Principal And Interest, Assume
$450,000 @ 5% Amortized Over 25 Years)
|Annual Cash Flow||$71,900|
|Return On Investment|
($10,772 / $150,000)