What kind of ROI did I get from my Home? I am often asked about housing and whether it is a good investment, and I am amazed how differently people see it. Forget investment property for the moment and consider how we should evaluate the investment performance of our own homes. We need to understand the difference between “enterprise value”, which is the sales price of a home (including your deposit plus what you still owe on the mortgage), and “equity value”, which is what is left at the end of the day when you sell your home and pay off the mortgage. In determining whether this was a good investment for you, it is only the latter calculation that matters.
Most people simply look at how much the value of their home has appreciated since they bought it, and compare it to what they paid. Let’s say someone bought a home for R1 000, 000 a year earlier and their neighbour’s identical home just sold for R1 100, 000. Simple math would suggest a potential 10% return in one year (a R100, 000 profit on a R1 000, 000 purchase). This, while straightforward, is not an accurate calculation for several reasons.
First, it is critical to factor in transaction costs on the sale of your home and deduct them from the gross sales price to see how much of the sales price you have left. These include what it might cost you to prepare the house for sale (painting, landscaping, window-dressing in some cases), as well as real estate commissions and other transaction related costs. Let’s say in our hypothetical example our seller would invest R20,000 in sprucing the place up for sale, and the real estate commission plus other closing costs (IE Beetle & Electricity) on the hypothetical R1 100,000 Selling Price might be another R66,000 (say 6% of the sales price). Thus that R1 100,000 sales price results in only R1 034,000 after these transaction-related costs, implying a mere 1.4% return (R14,000 profit on a R1 000,000 purchase price), right? Wrong again.
To calculate your investment return you need to compare your profit (or loss) to the equity you have invested, not the entire home price. Let’s say you put 5% down to buy the home, which equated to R50, 000. Your R14 000 profit in this case actually represents a very attractive 28% return on your investment in only one year.
One way homeowners can increase their returns is to appreciate how much the return on their invested equity can be enhanced by saving say 1% in the agent’s listing commission. In the example above, a 5% sales commission vs. 6% would have increased our hypothetical seller’s return on their R50,000 of equity investment from the 28% we just calculated to an astonishing 50% (R 25 000 profit on the R50,000 investment).
While the above is a hypothetical scenario there are a couple of factors we should still take into consideration; 1) We have not included home maintenance, usually about ½% of the total selling price. Secondly, make sure to factor in all costs of the transaction. Thirdly, understand the difference between the home value and the equity you have invested in the home, which is what impacts your true economic return. Fourthly, appreciate the impact sales-related costs can have on your return. While a 1% commission difference seems relatively insignificant in the context of a R1 110 000 home sale, it is VERY significant in relation to the equity investment in your home, which is the basis of determining your return on your investment.
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