Most people invest in real estate to generate income and build wealth over time. One of the main ways to build wealth is with rental properties. However, before buying real estate, knowing how to calculate ROI for a rental property is crucial to ensure it’s a smart investment. In today’s article, we’ll go over what a good ROI for rental property is and how to calculate potential returns.
Contents of This Article:
- What Is ROI for Rental Property?
- How to Calculate ROI for Rental Property
- What’s a Good ROI for Rental Property?
- Importance of Calculating ROI Before Investing
- Maximize Your Rental ROI With Property Management
What Is ROI for Rental Property?
ROI stands for return on investment, which in this case, is how much you make from your rental property. It’s important for investors and Washington DC property management companies to understand how to calculate and maximize profits in a rental property. That said, the ROI for a rental property is the ratio of your net income to the amount of money you invest in the property.
Your net income from a rental investment is the total income you generate from monthly rent payments minus all expenses. Common expenses include property taxes, insurance, maintenance costs, and mortgage payments. Additionally, the amount you invest in a property consists of the down payment, closing costs, and other expenses related to buying the property. Next, we’ll go over calculating your ROI and what makes a good return.
How to Calculate ROI for Rental Property
One of the easiest ways to calculate the ROI for a rental property is by subtracting your annual operating costs from your yearly income and dividing the total by the mortgage value. However, there are several ways to determine how much of a return you may receive when investing in real estate.
One of the easiest ways to calculate the ROI of a rental property is by looking at your cash flow. Cash flow is the amount of cash you have left over after each month from a rental property after paying all the necessary expenses.
- Cash Flow = Gross Rental Income – Property Expenses
For instance, say you make $1500 each month from your rental. From that, you’d subtract your mortgage payment, property taxes, insurance, property management fees, vacancy costs, and repair costs.
Next, calculating the cash-on-cash return can give you a good idea of how well your investment property will perform. It shows the ratio of annual cash flow to the amount of cash you invested.
- Cash-on-Cash Return = Annual Cash Flow / Initial Investment Amount
Once you’ve calculated your monthly cash flow, you can determine your cash-on-cash return. For instance, say you make $200 monthly after all your expenses are paid. In that case, your annual cash flow would be $2,400. From there, you’ll want to add up your initial cash out of pocket, including the down payment, closing costs, and repair costs.
So, say you spend $24,500 out of pocket on your investment. Then, to calculate your cash-on-cash return, you would divide $2,400 / $24,500 to get a percentage of 9.79%.
Net Operating Income (NOI)
The net operating income (NOI) is similar to cash flow since it measures rental income minus operating expenses. However, the biggest difference between NOI and cash flow is that NOI doesn’t factor in mortgage or repair costs.
- NOI = (Rental Income + Other Income) – Vacancy Costs and Operating Expenses
For instance, if your rental income is $1500 per month, you’d subtract your operating expenses from that total amount. So, if your operating expenses and vacancy costs add up to $850, your NOI would be $650.
Calculating the NOI for a rental property is helpful when comparing potential investments. For instance, it gives you a gauge of your returns without the details of loan terms.
The capitalization rate, or cap rate, can estimate how much you’ll make on an investment. It’s similar to the cash-on-cash return, but it doesn’t factor in loan expenses. Additionally, it looks at the property’s purchase price instead of the total amount of cash you invested.
- Cap Rate = NOI x 12 Months / Purchase Price
Say you buy a property for $100,000. To find the cap rate, multiply your NOI ($650) by 12 months to get $7,800. Then, divide it by the purchase price, $100,000, to get your cap rate of 7.8%.
What’s a Good ROI for Rental Property?
Determining a good ROI for rental property can vary depending on several factors. For instance, you must consider the location, property type, local market conditions, and investment goals. Generally, a good ROI for rental property is considered to be around 8 to 12% or higher. However, many investors aim for even higher returns.
It’s important to remember that ROI isn’t the only factor to consider while evaluating the profitability of a rental property investment. You’ll also want to consider the cash flow, appreciation potential, and tax benefits of investing in real estate.
Ultimately, what constitutes a good ROI for rental properties depends on your goals and circumstances. That said, it’s crucial to thoroughly research the market and carefully analyze your finances before making any investment decisions.
Importance of Calculating ROI Before Investing
You should calculate the ROI of a rental property for several reasons before going through with an investment. Here are a few reasons why you should run the numbers before making a real estate purchase.
- Evaluate Profitability– Calculating the ROI of a rental property allows investors to assess the potential of an investment before making a purchase. By comparing your expected returns with the amount of money you need to purchase and maintain the property, you can better determine whether or not it’ll be profitable.
- Set Investment Goals– Calculating the profitability of an investment can help you set clear goals and determine how much risk you’re willing to take on. That said, you may want to shoot for higher returns if you’re looking at a risky investment.
- Compare Investments– Calculating ROI allows investors to compare different opportunities and determine which one makes the most sense according to their financial goals.
- Identify Areas for Improvement– Finally, calculating ROI for rental properties can help investors identify where to improve or make adjustments to maximize profitability. For instance, if your ROI is lower than expected, you can find ways to reduce costs or increase rental income to improve your rate of return.
Maximize Your Rental ROI With Property Management
If you’re looking for a good ROI for rental property, it’s important to look at your management practices. After all, the key to a successful rental is proper management, quick maintenance, and excellent communication. If you don’t put time and effort into managing your properties, it may be hard to find long-term reliable tenants.
So, if you want to improve your rental management practices and increase your ROI, consider hiring comprehensive property management. Bay Property Management Group has the expertise and professionalism to help your rental business succeed. Contact BMG today to learn more about our services and how we can help maximize your property’s ROI.