The only way to know whether your rental property investment is lucrative or not is to calculate the ROI – return on investment. Every landlord should know how to calculate ROI to make sure his rental investment is a profitable one.
ROI is easy to calculate, but it’s also very easy to manipulate as well. There are many calculations that are to be included or excluded to calculate the absolute number, such as cash payments or mortgage. Take a look at the following popular methods of calculating ROI impeccably.
The Simple Formula of return on investment is:
ROI = (Profit from Investment – Cost of Investment)/Cost of investment
For example, if you have $100,000 in your investment rental property and your total profits roughly sums up to $120,000, your ROI will be:
ROI = ($120,000 – $100,000)/$100,000 = 0.2 = 20%
Now, this is the simplest form of the formula to calculate ROI, know that these numbers are estimated, and these numbers aren’t proved as well. Generally, the cap rate and the cash on cash return are used to calculate the exact amount of ROI.
Cap Rate Calculation for ROI:
Cap is perfect for comparing similar real estate investments. Also, its mostly calculated when the investor is paying in full cash for his rental property. It is the ratio of the property’s net operating income and purchase price of the rental property.
NOI =Rental Income – Operating Expenses
Cap rate calculation formula is:
Cap Rate = NOI/Purchase Price × 100%
Example:
Total cost of purchase, closing cost and renovation = Total Investment = $110,000
Tenant rent for a year = $9600
Other expense: $2000
Annual return per year = $9600 - $2000 = $7600
Now the calculation of ROI:
Cap Rate = ($7,600/$110,000) x 100% = 6.9%
6.9% is your ROI on your rental property
Rate of Return For ROI:
CAP is far easier than calculating the rate of return. Most investors, who pay for their rental through mortgage or loan, the use rate of return to calculate their ROI. It is the ratio of your property’s annual NOI and the total amount of cash invested in the property. The formula is:
Cash on Cash Return = (Annual Cash Flow/Total Cash Invested) × 100%
For example, you bought your rental property for $200,000 rental property, you paid 20% as down payment, and rest is your mortgage. The calculation is:
- $40,000 for the down payment ($200,000 purchase price x 20%)
- $4,500 for closing costs
- $5,000 for remodeling
- Total cash invested is $49,500 ($40,000 + $4,500 + $5,000)
With mortgage payment and your rent received if the annual income is $3,600 then your ROI from the rate of return is:
Cash on Cash Return = (3,600/49,500) x 100% = 7.27%.
How to know your Rate of Return on a Rental Property is a good one?
Most commonly it is believed that if the rate is over 15% then is a good one, but it depends on your location as well as the size of your rental along with risk association.
According to the different methods of calculating, the percentage also varies.
- By the method of CAP, it should be around 10% to 12%
- By the method of the rate of return on 8-12%
- Many experienced investors don’t invest in the property until their calculation gives them a percentage above 20%.
Being able to measure the ROI rate with all three different methods is a must skill that every landlord should have. If you want to know whether your property is a lucrative one or not ROI is the only thing that will help you.
If you’d like to talk more about property management, or you need help with Everest Property Management, please contact us at Everest Realty.
As a top producing Realtor and Property Manager; Terry specializes in sales, extensive construction homes, rentals, REO’s, short sales, and all aspects of Real Estate. After graduating the University of Michigan with a master in MBA, Terry continued his endeavor and now has over 15+ years of experience in the Real Estate world. If there is anything that has to do with Real Estate and sales, you can always be sure of Terry to provide important, specialized knowledge.
