What is Real Estate Investment Payback Period?
The Real Estate Investment Payback Period is the time required on an investment to generate enough money to recoup the original cost.
Table of Contents
- How to Calculate Real Estate Investment Payback Period
- Real Estate Investment Payback Period Formula
- What is a Good Payback Period in Real Estate Investing?
- Real Estate Investment Payback Period Calculator
- 1. Commercial Real Estate (CRE) Property Assumptions
- 2. Real Estate Investment Payback Period Calculation Example
How to Calculate Real Estate Investment Payback Period
The real estate investment payback period measures the time between the date of initial purchase and the date on which the break-even point is met.
In the context of commercial real estate (CRE) investing, the real estate investment payback period is the estimated time necessary for the cumulative rental income of the investment property to match the original purchase price.
The break-even point (BEP) in real estate investing refers to the state at which a property’s annual return is equal to the original purchase price (or current property value).
Conceptually, the real estate payback period measures the recovery time in which the investment property remains unprofitable (and thus operates at a loss).
Since the total rental income and cost are equivalent at the break-even point, the investment property is, at that point, generating neither a profit nor a loss.
The rental income produced beyond the break-even point represents “excess” profits for the property owner (or real estate investor), i.e. the yield on the investment is then net-positive.
The process to calculate the real estate investment payback period consists of three steps:
- Calculate Total Cost of Investment → The sum of the purchase cost, including closing costs, renovation costs, and fees paid for professional services (e.g. appraiser, real estate agent).
- Determine Annual Return on Investment Property → The cap rate on the investment property is divided by the total property value (or sale price, inclusive of adjustments for other fees).
- Estimate the Real Estate Investment Payback Period → The number of years to break-even is the total investment cost divided by the annual return in gross terms.
Real Estate Investment Payback Period Formula
The real estate investment payback period, or the number of years required to break-even, is calculated by dividing the total investment cost by the annual income expected to be generated per year.
Where:
- Property Value → The property value, or total cost, is the total spend while completing the property investment, including the direct property-level expenses incurred across the holding period.
- Annual Return → The annual yield on the investment property multiplied by the property value at present.
The calculation output will be expressed in terms of the number of years.
Therefore, a payback period of ten years indicates that the real estate property investment will break-even and start to produce a profit after ten years.
There is no standardized method for calculating the metric, as the context of the analysis determines which costs to include (or exclude).
For instance, when estimating the time required to break-even on an investment on an individual basis, it is far more common to include additional discretionary adjustments compared to when performing a break-even analysis to compare the property against an industry benchmark set by comparable properties (i.e. “apples-to-apples”).
Note: The property types for which the payback period is analyzed are usually acquisitions of stabilized (or near stabilization) properties, such as core or value-add investments, rather than for development projects.