There are countless reasons to invest in rental properties. Some choose to purchase a rental property as a way to bring in a little extra income. For others, rental properties are long-term investments to fund their retirement and secure their future. Whatever your reasons for investing in a rental property may be, it’s important to take steps before you buy a property to determine the right investment for you. Calculating your potential ROI is one of the most important steps so let’s talk about how to calculate ROI on rental property.
How to Calculate ROI on Rental Property
What is ROI?
At the end of the day, the basic motivation behind buying a rental property is to make money. Every investor purchases property with the hope that they’ll be able to make more from the property than they have to spend on it.
ROI means Return on Investment, and it’s a fairly straightforward way of measuring the amount of money you’ll get back on your investment, compared to the amount of money you’ve put into it.
Rental properties are unique in that they offer two types of financial returns: regular cash flow in the form of rent, and long-term appreciation of the property’s actual value. Both must be factored in when calculating ROI, and as an investor it’s also important to decide which you want to prioritize.
There are several potential metrics for figuring out how profitable a rental property may be, but ROI is one of the simplest. It’s typically expressed as a percentage of the cost of the investment.
Simple ROI formula
At its most basic, calculating ROI involves two steps. First, subtract the cost of the investment from the income from the investment, to arrive at the net profit (sometimes called net gain) of the investment. Then, divide that number by the cost of the investment to determine your ROI.
Written out, the formula looks like this:
- (income from investment – cost of investment) / cost of investment = ROI
Sample ROI calculation
Let’s go through a very simple example of an ROI calculation to get a better idea of how the formula works. Let’s say you’ve invested $100,000 in a rental property, and the total profit from your investment is $125,000.
When you subtract the cost of the investment from the income from the investment, you’re left with a net profit of $25,000. Divide the net profit by the cost of the investment, and you’re left with an ROI of 0.25, or 25%.
Written out, here’s how that calculation looks:
- ($125,000 – $100,000) / $100,000 = 0.25
Variables that affect ROI
As you’re probably already thinking, most real-world investments aren’t quite that simple. This is especially the case with rental properties. A wide range of variables can impact your ROI.
Some of those variables are expenses that you will accrue in addition to the cost of the property itself. These include closing costs, renovations, repair and maintenance expenses, property management fees, taxes and insurance.
If you take out a mortgage to finance the purchase of your rental property, that adds another layer of complication to figuring out your ROI. The amount of money borrowed with interest has a huge impact on your final ROI, as do the terms of the financing.
With all these variables in mind, it’s no surprise that many landlords turn to a professional to help them figure out the ROI of their prospective investment.
Contact us today to learn more about choosing the right investment property, and talk to our team about making the most of your investment. Juggling your rental property investments while managing your day-to-day life can be challenging, and we’re here to help make the process smoother.
