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Rental properties are a great way to invest your money and grow your wealth over time. The rental income they provide and the potential for property appreciation typically leads to solid returns for investors. If you are invested in rental properties or have been considering adding a rental property to your portfolio, you will need an accurate way to calculate your return on investment. This can help you better manage your investments, and allows you to compare the returns with other properties in order to make smarter business decisions. Here’s a quick guide on properly evaluating and calculating rental property ROI.
Understanding Rental Property ROI
Return on Investment (ROI) refers to the amount of money you make from an investment divided by the total cost of the investment, represented by a percentage. For rental property investments, this is your total return after considering the property’s value, rental income, acquisition & renovation costs, and all related maintenance and upkeep expenses. You can also get more specific and calculate a property’s annual returns, which can be represented by your Cap (capitalization) Rate. Rental properties have the advantage of consistently generating income, which means your total return on investment will continue to grow so long as you keep renting out the property.
Gather Some Basic Property Data
The initial steps of evaluating a rental property’s return requires gathering accurate numbers for monthly income, maintenance costs, mortgage expenses, property taxes, insurance, and also Homeowners Association fees if applicable. There are certain factors that will affect a rental unit’s monthly rate, such as the property type, size of the unit, and how many bedrooms, bathrooms, or other amenities there are in the unit. The location of your property will also have a big effect on rental demand. A great neighborhood can lead to significantly better returns, so be sure to do market research and find a good area before making a purchase decision.
Calculating a Rental’s Return
Accurately estimating rent is the first step to calculating a Rental Property’s ROI, but you should also take some other factors into account. Income projections will change over time as demand in an area varies. You should try to get hold of some data on rent projections in your area, so that you can factor it into your calculations. Here are some other factors you should know about that can affect your return on investment:
- Cash Flow: This refers to the net cash your property generates after considering all monthly expenses. A positive cash flow means the property brings you money reliably every month. Your long-term goal should be to maximize cash flow by gradually reducing your costs.
- Operating Expenses: There will be regular costs to consider such as the property’s mortgage, taxes, and insurance, but maintenance fees will vary from month-to-month. You may also have business expenses to consider, like for example, a property manager you’ve hired. Keeping track of your expenses is the first step to keeping them under control, and hopefully minimizing them.
- Financing Costs: Getting access to better financing can also affect your investment’s profitability. Even if rates may be higher at the time of buying, you may be able to refinance your property later down the line to decrease your monthly payments and increase your cash flow. It may be worth shopping around to compare lenders and see which one is the best fit for your project.
Capitalization Rate
In real estate, your Capitalization Rate measures how much of a return an investment brings you every year relative to its price. You can calculate a property’s Net Operating Income (NOI) by adding all 12 months of rental income and subtracting the year’s expenses. Then simply take this number and divide it by the purchase price to find the Capitalization Rate. Rental properties with a healthy cap rate in the 5-10% range make for the best investments, as they generate a solid return while not involving too much risk.
Final Tips
Rental Properties make for such good investments because on top of the rental income they provide, they can grow in value over time with appreciation. You can even make use of tax advantages like depreciation by conducting a cost-segregation study. Consult with an accountant or another tax professional to make the most of your deductions with rental properties.
There is also no replacement for taking the time to conduct due diligence. This often means thorough research and planning before making any purchase decisions. You will need to account for market fluctuations and other property management challenges you may face over the course of your investment. As with any investment, you are more likely to succeed when you make smart decisions based on reliable data.
RCN Capital
The easiest way to save on a rental property purchase is to find a trusted lender that can get you the best leverages and rates. RCN Capital lends to real estate professionals, commercial contractors, developers & small business owners across the nation. We provide short-term fix & flip financing, long-term rental financing, and new construction financing for real estate investors. RCN Capital also has flexible and competitive loan options available. Are you looking to purchase or refinance a long-term rental property?Connect with us today.