ROR or the Return on Total Capital measures the income return of a commercial property assuming that
there is no borrowing.
This measure along with many other real estate investment performance measures is discussed in the e-book Real Estate Investment Mathematics.
Return on Total Capital is equivalent actually to the overall capitalization rate or free and clear rate of return, as it is calculated as the ratio of NOI over purchase price or total capital invested.
If total capital invested is used though, it could be slightly different than the overall capitalization rate or income return, where the denominator is the purchase price. Total capitalinvested can be higher than the purchase price, as it may include other acquisition and pre-acquisition costs, such as notary and other governmental fees associated with transfer of ownership, legal due diligence, market studies, feasibility studies, engineering and environment studies, etc. The formula for ROR is the following:
Return on Total Capital= NOI / Total Capital Invested
Example (continuing from previous)
NOI =$100,000
Total Capital Invested =$ 1,050,000
Return on Total Capital = 100,000/ 1,050,000 = 0.0952 or 9.52%
We used here the total invested capital, which is on purpose assumed greater than the purchase price of $1,000,000 in order to demonstrate that Return on Total Capital can be different than the overall capitalization rate or income return. This is an excerpt from the e-book Real Estate Investment Mathematics.
Problems of ROR
The major disadvantage of the return on total capital as an investment performance measure is that it ignores completely the financial structure of the transaction and the use of borrowed funds, which can alter considerbly the retur on investor equity. In fact, if the necessary conditions are met so that the use of borrowed funds result in
positive leverage, the return on investor equity can be enhanced considerably.
The other important deficiency of the return on total capital as an investment performance measure is that if fails to account the effect of income taxes, which can alter significantly the ultimate return delivered to the property investor.
Return from ROR-Return on Total Capital to Investment Analysis
