Compounded Return 3 The second way and more precise way to measure the ROI of a unit renovation is to actually calculate the compounded return (often called the Internal Rate of Return or IRR) you’d achieve from the renovation. To do this, we need a few more pieces of information than in the example above. Specifically, to determine the IRR, we need to account for all of the benefits of the upgrades, as well as the timing of those benefits. To continue the example from above where we spent $3,500 to generate an additional $125 per month in revenue, we also have to consider the number of months we expect to receive that additional revenue until sale, and the additional value that $125 in increased monthly income provides in terms of resale value. Let’s assume we expect to sell the property in six
years (72 months). In other words, we receive the additional $125 per month for 72 months. Further, let’s assume that we expect to sell the property at a 5% cap rate, meaning the $125 per month ($1,500 per year) will generate an additional $30,000 of value at sale ($1,500/.05). If we take the initial cost of the project ($3,500), the $125 in additional monthly income for 72 months, and the additional $30,000 captured at sale six years down the road and we plug these numbers into a compound interest calculator, we will find that the compounded return on our $3,500 investment is over 75%! Comparing this return to the cost of capital (the rate we need to pay to acquire the investment capital), we would likely see that the ROI far outweighs the cost of the capital, making this a profitable investment.
While there are lots of considerations that must be taken into account when determining the extent of renovation during any unit turnover, these are three of the most important to us. And they should be to you as well. FINAL THOUGHTS
J SCOTT Partner, Investor, Author, and Coach Bar Down Investments Connect with J
J Scott is an investor, entrepreneur, and author of five books, including The Book on Estimating Rehab Costs . He has completed over 400 single family flips and has completed renovations across more than 1,000 multifamily units.
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