• The annual rate of return measures an investment’s gain or loss over one year relative to its initial investment.
• Investors use the ARR to have a clearer picture of an asset’s performance over time.
• To get the annual rate of return, subtract the initial investment made at the start of the year from the current value, divide the difference by the initial value, and multiply the result by 100.
• The same principle applies to real estate, but upkeep costs for rental properties may complicate the calculations.
• Generally, a good average annual return on investment should be at least 6%, but this depends on the type of investment.

The annual rate of return (ARR) measures an investment’s change in value over 12 months[1]. The annualized rate can be positive or negative because it depends on what was gained or lost compared to the initial investment at the beginning of the year[2].

Comparing a property’s ending value to its beginning value over a set period strongly indicates future investment performance. As such, it affords investors a preview of how much money the property can make compared to the initial cost of investment[3].

ARR is also crucial in making routine investment decisions by seeing how different investments are performing[4]. For example, before purchasing an investment property, investors assess the property’s potential and how profitable it can be in the long run.

There are many ways to calculate annualized returns. One is to calculate the rate of return every month and then multiply it by 12[5].

To find the percentage increase over a one-year period, one should get the value of the investment from the beginning and at the end of the year. Then, subtract the initial investment made at the start of the year from the current value and divide the difference by the initial value. Finally, multiply the result by 100 to get the percentage[6].

Here is the formula to get the annual rate of return:

ARR = ([CV – IV] / IV) x 100

Where:

• IV is the initial investment value.
• CV is the current investment value.

For example, an investor bought 30 shares of a company, with each share valued at $20. The investor made a total investment of $600. A year later, each share was worth $25. The investor sells all the shares for a total of $750.

To get the investor’s annual rate of return, one must subtract the initial investment of $600 from the total year-end value of $750 and divide the difference by the initial investment. The result must then be multiplied by 100.

ARR = ([$750 – $600] / $600) x 100
ARR = (150/600) x 100
ARR = 0.25 x 100
ARR = 25

The investor saw an annual rate of return of 25%.

In real estate investing, the rate of return is a valuable metric for evaluating rental properties and investment properties for sale[7].

For example, a person invested $700,000 in residential property and sold it a year later for $850,000. To calculate the rate of return, one must subtract the initial investment from the final selling price and divide the difference by the initial investment. The result will then be multiplied by 100.

ARR = ([$850,000 – $700,000] / $700,000) x 100
ARR = (150,000/700,000) x 100
ARR = 0.214 x 100
ARR = 21.4

The person’s return on the sale is 21.4%.

Annualized Rate of Return on Rentals

When it comes to real estate investments, there is more to it than just the buying and selling price. For example, to calculate the rate of return on a rental property, one should also consider the costs of remodeling, closing, and operating expenses[8].

Say an investor purchases a $200,000 rental property. The investor also spends $15,000 on closing and remodeling expenses. That means the initial investment is worth $215,000. The investor then rents out the property for $2,500 per month. In a year, the investor collects $30,000 in rent.

The investor deducts $7,000 in operating expenses to get the net operating income (NOI). Then, to calculate the rate of return, the investor will divide the net operating income by the initial investment and multiply the result by 100.

ARR = (NOI / IV) x 100
ARR = ($23,000 / $215,000) x 100
ARR = (23,000/215,000) x 100
ARR = 0.107 x 100
ARR = 10.7

The rental property’s rate of return is 10.7%.

Different types of real estate investments offer different returns. A good rate of return on a rental property, for example, will depend on many factors, including property type, location, condition, risks, and the like[9].

Investors also consider their long-term goals when choosing investment properties. Some invest in properties they think will appreciate quickly, while others choose properties that generate good rental income in the long term[10].

Generally, a good average annualized return on investment should be at least 6%[11]. For comparison, the average ARR on the stock market’s S&P 500 is around 14%[12].

BY THE NUMBERS: REITs outperform U.S. stocks more than 56% of the time in terms of annual returns.

Source: Nareit

1. Hayes, A. (2021.) Yearly Rate Of Return Method Definition. Investopedia. Retrieved from https://www.investopedia.com/terms/y/yearly-rate-of-return-method.asp
2. Hawk, R. (2022.) What Is Negative Rate of Return? SmartCapitalMind. Retrieved from https://www.smartcapitalmind.com/what-is-negative-rate-of-return.htm#comments
3. Abdul-Samad, H. (2020.) How to conduct a rate of return analysis in real estate. Mashvisor. Retrieved from https://www.mashvisor.com/blog/rate-of-return-analysis/
4. Titan.com. (2021.) What Is a Rate of Return? Retrieved from https://www.titan.com/articles/what-is-rate-of-return
5. The Motley Fool. (2020.) How to Calculate a Monthly Return on Investment. Retrieved from https://www.fool.com/knowledge-center/how-to-calculate-a-monthly-return-on-investment/
6. Best, R. (2022.) Rate Of Return: Formula, Calculation & Examples. Seeking Alpha. Retrieved from https://seekingalpha.com/article/4467051-rate-of-return
7. Smartgroup.com. (n.d.) Understanding Real Estate Investment Returns. Retrieved from https://www.smartcapgroup.com/blog/understanding-real-estate-investment-returns
8. Ziraldo, K. (2021.) What Is ROI On Real Estate Investments And How Do I Calculate It? Rocket Mortgage. Retrieved from https://www.rocketmortgage.com/learn/roi-real-estate
9. McBride, G. (2021.) Average return on investment: What is a good return? Bankrate. Retrieved from https://www.bankrate.com/investing/good-return-on-investment/
10. Wall StreetSurvivor. (2022.) What is a Good Annual Rate of Return? Retrieved from https://www.wallstreetsurvivor.com/good-annual-rate-return/
11. SoFi.com. (2021.) What Is Considered a Good Return on Investment? Retrieved from https://www.sofi.com/learn/content/good-return-on-investment/
12. Knueven, L; Houston, R. (2022.) The average stock market return over the past 10 years. Business Insider. Retrieved from https://www.businessinsider.com/personal-finance/average-stock-market-return