How To Calculate ROI on Your Rental Property
Owning and managing a rental property all comes down to finding a balance between costs and income. Great tenants will regularly be a good investment, but everyone knows that each lease has some risks included. Understanding the rental process is the best way to ensure a good outcome, knowing your local laws and managing fair tenant expectations.
But while most owners and property managers are looking for a good return on investment or ROI, not everyone knows what that ROI is and how to calculate their success. Learn how to better understand your rental number with some simple tips.
How to calculate ROI
The exact numbers used to calculate ROI are pretty simple. You consider both your gains from your investment and also the costs. Mathematically, you can use this simple formula:
ROI = (investment gain - cost of investment) / cost of investment
The resulting number you get from this entry will return you a figure such as .22, which you then convert into a percentage by multiplying by 100. In this case, you would have a 22 percent ROI on your property.
And while the math is simple, getting the numbers to plug into this formula is a little more complex. You'll have to customize your calculations based on whether you purchased in cash or still have a loan payment, among other factors.
Determining the cost of your rental property
The cost of your rental property is more than just the cost of your purchase price or mortgage. You'll need to also consider things like property taxes, insurance and closing costs.
In addition, depending on the nature of your rental, you may need to include maintenance costs — both emergency and regular maintenance, plus landscaping, pool costs and those created by other property amenities.
Some properties will also need to factor in the costs of utilities, such as water, sewer, gas and electricity. Even if a tenant will be responsible for these items, a landlord will have to cover any shortfall during vacancies. Finally, your investment can include annual fees for advertising, HOAs and management. If you hire a firm to manage your property, those fees would be factored into your yearly costs, as well.
Roofstock helps explain the difference between cash purchase costs and loan purchase costs. While a cash sale would calculate the initial purchase and maintenance or utility costs against gains, a loan purchase works a little differently. In the first year of a loan, the cost of the home would look more like this according to their experts:
Initial cash out of pocket = down payment + closing costs + rehab costs
Subsequent years would not need to factor in the down payment, but would instead factor in mortgage interest, mortgage insurance and any processing fees involved with the loan.
Determining the gains from your rental property
Next, you'll need to determine how much money is coming in from your rental property. On the basis, this is a simple number as your primary gain will be the money earned in rent. For example, a property renting at $2,000 per month would have a gain of $24,000 a year if fully occupied. Fees and refundable deposits are generally not considered gain or income.
Some owners also like to factor in the equity gained during ownership, especially in today's hot housing markets. Equity is added to your annual cash flow if looking for a holistic investment picture and it will help provide a cohesive view of how well your investment is doing in gaining your assets. It's important to understand that equity does not reflect the cash flow of your investment return, however, so don't use this formula if looking to understand your available assets.
Understand your rental property's ROI
Knowing your ROI is a fantastic way to help plan your budgets and understand the success of your rental property. Experts suggest that a return of 10 to 15 percent on a mortgage rental property or 8 to 12 percent on a cash property is a success. Some owners prefer to work with a 20 percent ROI before they consider a property effective.
Determine your own ROI to see where you rank and monitor this number over a period of years. Determining ROI is simple, and lets you move on to planning your next big investment.