Once you own and manage a rental property, you will realize that it’s a profitable and rewarding experience. As you may know, one of the most critical components of any investment strategy is knowledge. There are several ways you can invest in real estate but before you proceed, learning how to use ROI calculation rental property strategy is a top priority. Before putting your money and reputation on the line, invest time in learning the business model first.
The most challenging part about investing in real estate is finding the right property and knowing if it will pay off in the long run. Learning the basics of rental property investing and calculating a property’s return on investment (ROI) is crucial.
Keep reading this guide on how to use ROI calculation rental property value.
What Is ROI or Return on Investment?
As a popular profitability metric, ROI is used to measure the amount of return on your specific investment relative to the cost. It helps evaluate the performance or profitability of your venture or compare the profitability of various types of investments.
To know the property’s ROI, you divide an investment’s net profit (or loss) by the initial cost or outlay. This tool is also used to compare and rank investments in various assets or projects.
How To Calculate the ROI of an Investment Property
You don’t need to be a math genius to learn how to measure a property’s ROI. To provide an accurate calculation, you must first understand the various variables that you should include or exclude to achieve an accurate figure.
To calculate the ROI of an investment property, you must first gather the basics of the property. Below are the important figures you need to remember when calculating ROI:
Cap Rate: In other terms, this refers to the capitalization rate and it represents the rate of your returns. You can calculate this by dividing your NOI (net operating income) by the cost of the property.
Net Operating Income (NOI): This is the indicator of how profitable your investment is. You can determine your NOI by subtracting the gross income against your operating expenses.
Cash-on-Cash Return: This is the amount you expect from your initial investment in the rental. To calculate the number, simply divide the after-tax annual cash flow by the total cost of the purchased property.
Annual Cash Flow: You can calculate the annual cash flow by deducting the debt from the net operating income. Once you have the number, it will show how much you will profit or lose from your rental per year once the expensed and mortgage payments are deducted. You can also take advantage of a rental property cash flow calculator. The property calculator looks into taxes, property management, mortgage payments, vacancy factors, maintenance, and insurance to give you an idea of the actual cash flow of your property.
Annual Gross Rent Multiplier: Also known as GRM, this helps measure the value of your rental investment. Through this tool, you can see if the property asking price is reasonable. You can compute this by dividing the total overall sales price by the cost of the annual gross rent.
To sum it up, the formula for calculating your ROI is as follows:
ROI = (the cost of your investment is deducted on the rental income or gain) divided by the total investment cost.
Usually, above 10% ROI for a rental property is good but 5% to 10% is within the acceptable range. You can also use an investment property calculator to help you compute your ROI.
When it comes to ROI calculation rental property formula, there is no right or wrong answer. There are various risk levels that different investors take. That is why if you are serious about investing in rental property, you should know your budget and analyze your potential returns.
Importance of Calculating ROI
Not all properties are ideal rentals, although, at first glance, they may look perfect. But when you discover their hidden fees and expenses, you may realize they are not worth the risk. This is why you should analyze your returns before investing in real estate.
Searching for an investment that offers the best ROI is ideal but calculating the ROI of your rental property is crucial. Below are the advantages:
It measures the profitability of your property
Once you know how to figure out the ROI for your rental properties, you can easily identify your net income.
As an investor, you should know the performance of your investments based on how you are using the asset to earn profit.
It helps you analyse units
Calculating real estate ROI is an important skill so you can compare different rental properties in terms of their profitability. You can use the figures if you want to measure the profitability of properties in different states especially if these properties have the same size and are located in similar neighborhoods. The ROI value will help you decide how much money you need to invest in unique properties to ensure their optimum profitability.
It helps you achieve your investment goals
If you want to know where you are in terms of your investment goals, you can look at the ROI ratio or percentage. This can help you track your investment goal and any increase in value helps improve the overall ROI of your rental investment portfolio.
It matches with accounting measurements
ROI is accepted in traditional accounting since it is also a financial accounting measurement. There is no need for you to create new accounting measurements just to get the values needed when calculating ROI. All values within the formula are available in financial statements found in conventional accounting systems.
The Bottomline
Your primary goal of investing in any rental property is to grow your profit. Searching for the right rental property is only the first step. You also have to consider downpayment to determine its affordability. Investors should cover at least 25% downpayment, repairs and closing costs. Having at least 6 months worth of reserves for maintenance and mortgage payment is also ideal. Use an investment property mortgage calculator to help you determine how much is your monthly mortgage payments.
While investing in rental properties has a lucrative potential, proper planning and research are important. Make the right choice and invest in a rental property that offers the best ROI each year.
With these pointers, you can achieve your investment goals and enjoy financial independence. If you are eager to start your real estate journey, read through our blog to learn more!
