Property ROI: how to calculate it and why the quoted 8% is never real

ROI (return on investment) is the king of indicators for any property investment. But there are so many ways to calculate it, and so many ways to manipulate it so that it looks good, that many beginner investors make decisions based on a number that doesn't measure what they think it measures.

The basic property ROI formula

ROI = (Net gain / Capital invested) × 100

Simple in theory. The problem lies in what you put into each variable.

The most common mistake: confusing ROI with rental yield

Rental yield (annual) measures how much rent you collect relative to what you paid. ROI measures the total return on the investment, including the increase in the asset's value. They are two different things.

A flat that you let at 5% a year and that rises in value by 4% that year has a total ROI of 9%, even though the rental yield is only 5%. Ignoring capital growth hugely underestimates the real return of property compared with other assets.

The three types of ROI you need to know

• Gross ROI: Rental income / purchase price. Useful for quick comparisons, useless for making decisions.
• Net ROI: (Rental income - all costs) / (purchase price + purchase costs). Now it makes sense.
• ROI on your own capital (leveraged): If you finance with a mortgage, ROI is calculated on YOUR money put in, not on the total price. This is where leverage makes the numbers very different.

The power of leverage on ROI

A concrete example: you buy a €100,000 flat. You put down a €30,000 deposit and take out a €70,000 mortgage. The flat generates €6,000 net a year in rent. The mortgage costs you €3,000 a year in interest.

ROI on your own capital = (6,000 - 3,000) / 30,000 = 10%. If you had bought in cash: 6,000 / 100,000 = 6%. Leverage turns 6% into 10%.

The risk, of course, is that if the asset loses value, the losses are amplified too. That's why the entry point matters so much: buying at a real discount through bank-owned assets or auctions is the safest way to use leverage.

How to compare different deals using ROI

ROI is for comparing like with like. Which has the better ROI: a €150,000 coastal apartment with an €8,000 annual gain, or a €50,000 flat in a medium-sized city with €3,500? The first: 5.3%. The second: 7%. And if you bought the second at a 30% discount to the market, its potential capital growth makes it even more interesting.

When ROI lies

An ROI calculated only on the first few years will always be optimistic, because it includes the income but not the extraordinary costs that come later: special levies from the owners' association, renovations, changes of tenant, void periods. An ROI projected over 10 years, including pessimistic scenarios, is infinitely more useful than one for an ideal year.

To calculate it properly: Also use the detailed formula in how to calculate the real net yield. And if you want to look for assets where the ROI is solid from day one, start with bank-owned properties or court auctions, where the entry price already gives you a head start.