Understanding Real Returns in Real Estate Investments
While increasing property prices often equate to great yields, investors must note that real estate value does not automatically translate to real returns on investment. To determine the success of a real estate investment, it's essential to calculate the real returns.
Calculating Real Returns
Real returns allow investors to measure the true profitability of a property investment by considering various factors, including:
- Cost of purchase
- Rental income received
- Taxes paid
- Cost of owning the property during the holding period
Distinguishing between Nominal and Real Returns
Nominal return refers to the difference between the selling price and purchase price, while real return encompasses all financial considerations regarding a real estate asset. Additional costs such as transaction expenses and other fees incurred may not be considered in nominal returns.
Factoring Rental Income into Your Calculation
Rental income is a crucial aspect of real estate investments. The rental yield is calculated by dividing the annual rent by the total cost of acquiring the property and multiplying it by 100. For example, if a property costing Rs. 75 lakh produces Rs. 25,000 per month, the yearly income is Rs. 3 lakh, resulting in a rental yield of about four percent.
Factoring Expenses Incurred
Real estate investors often make miscalculations when it comes to costs associated with acquiring and maintaining the property. These expenses include:
- Property tax
- Repair and maintenance
- Insurance costs
- Legal expenses involved in selling or owning a property
Adjusting Computations for Inflation
Inflation affects the value of money over time. To accurately calculate real returns, investors must factor in inflation when assessing the property's appreciation. For instance, if the real estate appreciates by eight percent every year while the annual inflation stands at five percent, the investor may end up with a lower percentage return than expected.
Comparing with Other Investment Opportunities
Ultimately, it's essential to compare real estate investments with alternative sources of investment to determine whether or not the property was worthwhile. Calculating real returns provides a complete overview of the profitability of the property.
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