Like other investors, the main reason why you would invest in real estate is to make money, build wealth, and attain financial freedom. And, one type of asset that will let you do just that without too many responsibilities that come with managing a commercial property is a short-term rental. You just have to spruce it up to become attractive for tenants or guests, then wait for it to be occupied and earn passive income from rental payments.
Regardless of your intention, it is important that the property you are buying will generate high amounts of profits down the road. On that note, you should measure its potential return on investment (ROI) before signing on the dotted line.
In this article, you will learn how to calculate return on rental property investment and ensure it aligns with your investment goals.
What Is ROI in Real Estate
ROI is a performance metric used to calculate the efficiency of an investment. In real estate, it shows how well your money is being put to work by measuring the increase (or decrease) in value of your property over a given period of time. Simply put, property investment ROI tells you how much profit (or loss) your rental income has generated compared to the amount of cash you’ve invested. It can be expressed as a percentage or ratio and is usually computed annually or quarterly.
The Importance of ROI for Rental Properties
Knowing your property’s ROI is important as it will help you set realistic expectations and make sound investment decisions. It can also serve as a guide to calculate the amount of cash flow you need to cover all your expenses, including mortgage payments, insurance, repairs, and other costs associated with being a landlord.
Moreover, since rental properties are usually leveraged investments (meaning you borrowed money to finance the purchase), your ROI will be one of the factors used by lenders in deciding whether or not to give you a loan.
What Is a Good ROI for Rental Property
The answer to this question largely depends on your investment goals and the current market conditions. However, the average ROI on a rental property, which is considered good, should be anything above 12%. Still, there are other factors you need to consider such as liquidity (the ease with which you can convert an asset into cash) and risk (the possibility that you will lose money on your investment).
How to Calculate ROI on a Rental Property
Now that you understand what ROI is and why it’s important, let’s take a look at how to calculate it. The calculation process is actually quite simple.
First, calculate the total amount of revenue generated by the property in a given period of time. This includes rental income, fees collected from tenants (like late payments or damage deposits), and any other income generated by the property (like parking fees, laundry, etc.).
Next, calculate the total amount of expenses associated with the property in that same period. These include mortgage payments, insurance premiums, repairs and maintenance costs, management fees, and any other expense related to owning and managing the property.
Finally, get the difference between the revenue and expenses to get the net profit, and then divide it with the revenue to get your ROI percentage.
ROI = Gain on Investment – Expenses / Gain on Investment
Example:
Let’s say you purchased a rental property for $200,000 and it generated $30,000 in rental income during its first year. Your total expenses would be $25,000 ($15,000 in mortgage payments + $10,000 in other costs). This would give you an ROI of 16.6% ($30,000 – $25,000 / $30,000).
This is a pretty good ROI percentage considering that it is way above the average real estate return on investment that most investors look for.
However, you can make the process easier by using a vacation property investment calculator and getting some tips from the experts, like the one you can find on this page: https://theshorttermshop.com/roi-rental-property/.
Tips for Maximizing ROI on Rental Properties
Now that you know how to calculate your property’s ROI, it’s time to put that knowledge into action and start maximizing your profits. Here are a few tips to help you get started.
1. Keep your costs low.
One of the best ways to achieve a good ROI for rental property is to keep your costs as low as possible. This includes minimizing mortgage payments, choosing a property in a good location with low maintenance costs, and hiring a good property manager who can negotiate favorable rates with suppliers.
2. Raise rents strategically.
Another way to improve your ROI is by increasing rents slowly but steadily over time. Try not to push your tenants too hard, but make sure that your rents are still in line with the market average.
3. Get creative.
There are many ways to add value to your rental property and increase your ROI. This could include renovating the property, expanding its footprint, or adding new amenities, like a swimming pool or a gym.
4. Invest in property management.
Last but not least, you can improve your ROI by investing in quality property management. By outsourcing the day-to-day tasks of owning and managing a rental property, you can free up time and resources to focus on other aspects of your investment.
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The Important Role of Equity in Calculating ROI
Sometimes, the property’s equity is taken into account when one is to calculate investment property return. It is the market value of a property minus any money that you owe on it. For example, if you purchase a rental property for $100,000 and have a mortgage of $80,000, your equity would be $20,000.
So, why is it important?
Well, if you plan to sell a property in the future, your equity will be an important factor in determining how much money you make on the sale. In order to calculate your ROI correctly, you need to know both the total revenue and expenses associated with the property.
In general, it’s a good idea to only invest in properties that have a high equity value. This way, you’re less likely to lose money if you decide to sell in the future.
Other Factors That Affect ROI
While the process to calculate return on rental property investment is relatively straightforward, there are a few other factors that can affect your results.
The amount of time you hold the property
If you plan to hold onto a property for a long period of time, your ROI will be higher than if you sell it after a short period. This is because you’ll have more years to generate revenue and fewer years for expenses.
Changes in the market
The market can fluctuate greatly over time, so it’s important to keep track of how your property’s value compares to similar properties in the area. If the market drops significantly, it could negatively impact your ROI.
Tax laws
Tax laws can also affect your ROI. For example, if you invest in a property through a limited liability company (LLC), you may be able to take advantage of certain tax breaks that wouldn’t be available if you owned the property outright.
The Bottom Line
ROI is an important metric for any investor to calculate and monitor. By understanding how to calculate return on rental property investment, you can make sound decisions about whether or not a particular property is worth investing in. With careful planning and execution, you can use it as a tool to maximize profits from your rental properties.
Keep the above-mentioned tips in mind as you move forward and remember that there’s no one-size-fits-all answer when it comes to determining a good ROI. Every investor has different goals and needs, so make sure you tailor your calculations accordingly.
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