Real estate investor, Founder/CEO of TurboTenant: rental marketing, tenant screening, rental applications, rent payments, and more.
Investing in real estate, and more specifically in rental properties, can be one of the most lucrative and safe investments people can make. With long-term appreciation, a monthly cash-flow and tax advantages, owning and operating rental properties will increase your wealth so you can save for retirement, life events or for other reasons. It might seem intimidating to know where to start, but rental property investing is for anyone and everyone — no matter your age or experience.
I bought my first property when I was 19 and discovered the hardest part about getting started was finding the right property and knowing if the investment would eventually pay off. Let’s break down the basics of rental property investing and, most importantly, how to calculate the return on investment (ROI) for a property.
Types Of Properties To Invest In
For those new to real estate investing, rental properties can be single-family homes, apartment complexes, townhouses, duplexes, multi-family apartment buildings and more. The main advantage of owning and renting out a property is the monthly cash flow from rent payments — many argue it’s one of the safest investments you can make. Another bonus is that landlords can decide if they want a long-term or a short-term rental — both of which have different pros and cons depending on your goals as an investor.
Additionally, it’s important to know your budget and investment strategy as you begin your landlord journey so you can calculate the ROI correctly — for example, consider if you want to renovate the property or if you’ll need to fully furnish it if it’s a vacation rental.
What You Need In Order To Calculate The ROI
Now, you’ve found a potential property that you think would be the perfect rental, how do you know if it’s a good investment? That’s where calculating the ROI comes in. ROI measures the profitability of an investment, or in other terms, it measures the possible return relative to the cost of the rental property.
Here are the basics of what you’ll need to calculate the ROI:
• Property Details: This includes the property value, property repair costs, square footage and number of bedrooms.
• Mortgage Details: This would be the loan terms, down payment, closing costs and interest rate.
• Rental Income Details: Calculate what the monthly rental income would be, other monthly income and the anticipated vacancy rate percentage.
• Monthly Rental Expenses: You need to know what your monthly maintenance, monthly repairs, monthly utilities, monthly HOA/dues and property management costs will be.
• Annual Rental Expenses: This will be the annual property taxes and the annual insurance cost.
Knowing all of these details about a potential rental property will help you decide if it will be a good investment that aligns with your investment goals.
How To Calculate The ROI
Once you’ve gathered all of the important information regarding a property and you are ready to calculate the ROI, below are some of the important figures you will need to calculate. You can also use a rental property calculator to help you calculate the ROI.
• Net Operating Income (NOI): The net operating income or NOI represents how profitable your investment is. It can be calculated by subtracting the gross income minus your operating expenses for the property.
• Cap Rate: This is also known as the capitalization rate, which helps you quickly gain insights to compare rental investment opportunities. It represents the rate of your return and can be calculated by dividing your NOI by the price of the property.
• Cash-On-Cash Return: This represents the return that is expected from what you invest in the rental. To find out what this number is, you can divide the after-tax annual cash flow by what you paid to purchase the property.
• Annual Gross Rent Multiplier: This is also known as the GRM and helps measure the value of the rental investment. For example, it can help you see if the asking price is reasonable. To calculate the GRM you divide the total sales price by the annual gross rent.
• Annual Cash Flow: Annual cash flow is calculated by the net operating income minus debt. This is how much you will profit (or lose) from your rental annually after all expenses and mortgage payments are covered.
A good ROI for a rental property is usually above 10%, but 5% to 10% is also an acceptable range. Remember, there is no right or wrong answer when it comes to calculating the ROI. Different investors take different levels of risk, which is why knowing your budget and analyzing the potential return is imperative.
Sometimes a property might look great and seem like an ideal rental, but it might have hidden fees and expenses you hadn’t thought about —that’s why analyzing your return every time you invest in real estate is a good idea. As you begin your landlord journey, keep a property’s profitability — as well as your investment strategy — top of mind and you should see a positive ROI from your rental portfolio.