How is Return on Investment (ROI) calculated?

Return on Investment (ROI) is a key performance metric used to evaluate the profitability of an investment, and it is calculated by dividing the annual cash flow by the initial cash investment. This method provides a clear picture of how effectively the invested capital is generating returns over a specified period, typically a year.

The rationale behind using the initial cash investment in the calculation is that it reflects the actual out-of-pocket money the investor has put into the property, whether it be for the purchase price, renovation costs, or other upfront expenses necessary to facilitate the investment. By focusing on cash flow generated from the property relative to that initial investment, investors can assess their overall returns and make informed decisions about future investments or operational adjustments.

This formula is particularly valuable because it accounts for the true investment made by the owner and allows for a straightforward comparison of different investment opportunities. It highlights efficiency in generating profit, enabling stakeholders to strategically consider the performance of their investments in real estate or other asset classes.