As a real estate investor, buying rental properties is a great method of earning income. But it is critical that you know how to properly calculate the rate of return on your investments. This essential metric used to estimate the monetary-based performance of a rental can be a make or break calculation and one you should know. Here’s how to calculate your ROI and make sure it’s a good one.
The Simple Calculation
There are several different ways to calculate a rental return; however, to keep things simple, you may follow the formula:
Return on Investment = (Gain – Cost) / Cost of the Investment
To see this formula in action, let’s say that you spent $65,000 on the rental property that you have purchased. The profits you have had add up to $90,000:
ROI= ($90,000 – $65,000) / $65,000 = 0.38 = 3.8%
So, in this example, you have a return on your rental property investment of 3.8%.
The Capitalization Rate
Most landlords determine the capitalization rate in order to find the true return on investment.
This takes the amount of rent that the property makes each year and creates a percentage, based on the purchase price.
The figure is then taken and compared to the median rate associated with similar properties to determine if the property is succeeding in a lucrative way. An ideal cap rate should be anywhere between 4% and up to 10% – or, higher.
To figure out this rate, follow the steps outlined here:
- Calculate the Gross Income
- Deduct Annual Expenses to Determine the Net Income
- Divide the Net Income by the Purchase Price
- Translate into a Percentage
If you have a rental that makes $24,000 a year- after expenses – and you purchased it for $50,000, your cap rate would be .48 or 4.8%, which is considered to be an ideal cap rate for return.
While considered ideal, it is always best to try to increase the cap rate as high as possible.
Remember to determine the median cap rate of rentals in the area. If yours is near or above, you are typically considered to be “on target”.
If it is lower, it is time to make a few adjustments.
If you would like your rate of return to be higher on your rental property, there are many measures that you can take to succeed in the endeavor; however, why do it yourself when you can enlist the assistance of a property manager?
We here at Pioneer offer professionally-trained property managers that are capable of taking the challenges out of the rental business. In addition, they have the capability of instantly increasing your rate of return. To learn more, contact us today.