Payback Ratio: Know When You Will Recapture Your Initial Investment

jim kobzeff

by James Kobzeff
Sep 19, 2018

The Payback Ratio is just one of a variety of calculations investors might use when evaluating a real estate investment opportunity.

And though it's not as popular for making investment decisions as perhaps capitalization rate or internal rate of return, the payback ratio can provide some benefit to real estate investors.

What the Ratio Provides

Namely, it provides a good starting point for investment decisions because it answers the question: "How long will it take for me to recapture my intial cash investment from the property's anticipated future net cash flows?"

In other words, the investor can get an idea of how long it will take to collect enough cash flow from the property to offset the amount of cash it takes to make the purchase (e.g., the down payment and closing costs).

Formula:

Initial Cash Investment ÷ Annual Cash Flow
= Payback Ratio

Example

Let's say you're buying a rental property that will require $300,000 down, generates an annual cash flow of $28,000, and you want to calculate how many years it will take to recapture your cash investment.

$300,000 ÷ $28,000 = 10.71 years

Illustration

The following image is a screenshot taken from Pro RE Calculator that shows you the calculation and result from our example.

Rule of Thumb

Since Payback Ratio relies on data that's highly speculative (e.g., income and operating expenses), especially over a number of future years, it's not a measure investor's can rely upon to make an investment decision. Still, it can provide a benefit because it can help the investor determine which might be the better option when comparing several investment opportunities.

So You Know

Payback Ratio is just one of 62 calculations in ProAPOD's calculator:

Pro RE Calculator
Compute it quickly and easily.
james kobzeff author

James Kobzeff is a former realtor with over thirty years of investment property experience and is the owner/developer of ProAPOD Real Estate Software.