How To Calculate ROI On Rental Property

Who doesn’t love the idea of owning dozens of rental properties, receiving rental income from tenants, month after month after month? Whether you’re purchasing your first investment property or your hundredth door, every smart investor must understand how to calculate ROI on rental property.

In this guide, we’ll dive into the fundamentals of income real estate analysis from the perspective of the investor. You’ll learn how to run the numbers on a rental property, understand how to calculate return on investment, as well as gain a reasonable expectation for the rate of return you should receive when owning a rental property over the long term.

So, grab your calculator and get ready to take notes. You’re about to learn the skills that can make you a real estate millionaire.

• What Is Return On Investment (ROI) In Real Estate?
• Importance Of ROI For Rental Property Investors
• Formula For ROI For Rental Properties
• What To Consider When Calculating ROI
• How To Calculate ROI On Rental Properties
• Other Ways To Calculate Rental Property Returns
• What Is A Good Rate Of Return On Rental Property?
• Takeaways On Calculating ROI Of Rental Properties

What Is Return On Investment (ROI) In Real Estate?

The most critical component of any real estate deal is whether it will yield a profit or not. Investors have no desire to put money into something that will end up costing them more in the long run or will only give them a small profit. The metric they use to determine this is called return on investment, or ROI.

Investors use ROI to find properties that will work for their needs. Some real estate investors are looking for long-term holds that they can turn into rental properties, while others are looking for something they can fix and flip.

ROI will take all the expenses into account, including the purchase price, fees, monthly payments, taxes, repair costs, and even marketing costs to get the property sold or listed as a rental. ROI calculations on a rental property will look different from ROI on a fix and flip.

Importance Of ROI For Rental Property Investors

Rental property investors need to focus on ROI even more diligently than other types of real estate investing. Not only do they need to account for the upfront cost of purchasing and fixing up the property, but they also need to be able to cover ongoing costs including monthly payments, property taxes, HOA costs, repairs, and more.

A good ROI on the rental property varies wildly, so it’s important to understand the local market and how much an investment will yield in monthly rent before going all-in on a property.

Formula For ROI For Rental Properties

Before you get started deciding to purchase and rent out a property, you need to know how to calculate ROI on rental property. It’s not so easy to do, and can often be manipulated by leaving out key details. Choosing to pay with cash will require a slightly different calculation than investors who choose to purchase using a down payment and a mortgage.

The easiest way to calculate the ROI on a rental property as a percentage (%) is to use the basic formula:

ROI = (Net Profit / Total Investment) x 100

The higher the gain on the investment, the better the ROI. This numerical value is useful to help investors decide between different properties or even different types of investments. By comparing the ROI on the rental properties they can determine if those investments are worth their time or money.

It’s important to deduct all the potential expenses from your gross profit when calculating ROI on a rental property that you may purchase so that you don’t accidentally put your money into the wrong investment. Leaving out details to make an investment look better "on paper" will only hurt you in the end.

What To Consider When Calculating ROI

The expected ROI on a rental property depends on several factors. Estimating rehab costs is a critical component that many investors forget at the front end of the deal.

Some rental properties are turn-key, but others will require substantial repairs to be liveable for an investment property. Other expenses to include in ROI calculations include the following:

Investment Cost And Gains

The initial investment cost is how much you purchase the home for, the amount of cash you put into repairing it, and any closing costs and fees from the real estate deal.

If your investment property needs a new roof, for instance, it’s often helpful to find companies that are experienced and already follow the best roofing marketing tips. They can even help you save money by offering a lower rate. This can improve your overall gains on the property in the long term.

Property Taxes

Some areas have very high property taxes which can quickly eat into your profits if you’re not careful. It’s important to include these in the calculations for ROI.

It’s a total percentage of the value of the home. So a $250,000 home, with a 1% tax rate, will cost you $2500 per year in property taxes. 

Read Also: Taxes On Flipping Houses: The (Ultimate) Guide

Fees

Rental properties can come with many fees, such as the cost of property management. How do property management companies work? They charge fees to handle the day-to-day issues of a home. This typically incurs a fee of up to 10% of the gross monthly rental amount.

Homes that rent out for $1500 would require a payment of $150 per month to the property management company.

When investors are learning how to figure out ROI on a rental property, they also forget about HOA fees and other neighborhood costs. Don’t forget to include these vital fees in your calculation.

Vacancy

Every time a rental property sits empty it costs the investor money. It’s best to rent out a property all the time instead of leaving it vacant if you want to maximize your ROI.

The average ROI on rental properties plummets if those properties are left vacant for long periods of time.

Upkeep

Eventually, rental properties need repairs. Whether you need to update old appliances, fix a furnace, or repair a roof after a big storm, it’s critical to factor these costs into your ROI projections.

Often the expected ROI on a rental property is off because investors don’t include these numbers.

Insurance

A good investor knows to insure rental property investments. While they won’t need any sort of content insurance, they will need liability insurance and coverage for damage from storms and other problems.

Getting quotes for insurance in advance is an important part of the process. 

How To Calculate ROI On Rental Properties

Here’s how to figure out your rate of return in various investment scenarios:

Calculating ROI Of Cash Transactions

Paying in cash makes it simple if you want to know how to calculate ROI on rental property. It’s important to account for every dollar you put into the investment on a cash deal.

If you purchase a property for $150,000, the closing costs were $1500, and you didn’t need to invest anything in repairs, then your total initial investment was $165,000.

Let’s say that you get $1,500 in rent every single month for a year. That brings your rental income to $18,000.

After you account for property taxes at $1,000 and property insurance at $1,200 for a total of $2,200, you can then calculate your ROI.

The total of your return for the year would be $18,000 - $2,200 = $15,800.

Take this annual return amount and divide it by the amount of your original investment of $165,000. This means that ROI = $15,800/$165,000 = 0.095 or 9.5% ROI.

This example assumes no repairs, maintenance, vacancy, management, or other common expenses. Be sure to factor in all expenses when calculating ROI on rental property. 

Calculating ROI Of Financed Transactions

Financed transactions are more complex to calculate ROI than cash ones. Some companies who use the Brrrr method may have an even harder time calculating the ROI of their rental properties.

For the sake of calculations, let’s pretend that you purchased the same $150,000 property above. And instead of paying cash, you put down 20% or $30,000. Let’s assume the closing costs were double, at $3,000, and that you still didn’t need to make any repairs to the home. This means your upfront investment was $33,000.

The mortgage on a 3.5% interest loan over the course of 30 years would cost you $539 per month. Over 12 months, this means you’d pay $6468.

Using the same numbers for property taxes and insurance would give you an additional $2,200 in expenses.

Assuming the same $1500 per month in rent would give you $18,000 in rental income. Now, instead of just subtracting out the taxes and insurance, you also need to account for the monthly mortgage payments.

This calculation looks something like this: $18,000 - $6,468 - $2,200 = $9332 annual return.

Take this annual return amount and divide it by the amount of your original cash investment of $33,000. This means that ROI = $9,332/$33,000 = 0.28 or 28% ROI.

Other Ways To Calculate Rental Property Returns

Internal Rate Of Return (IRR) Or Annualized Total Return

Some investors use an internal rate of return or annualized total return calculation to determine the ROI on a given investment.

These calculations are both helpful in aiding potential investors to determine whether they should branch out with a new venture or expand on an existing one.

Capitalization Rate (Cap Rate)

Another way to calculate ROI is to divide the net operating income by the market value of the home. Some investors find this to be a useful tool in determining whether they will purchase a property or not. It’s very helpful in comparing two similar real estate properties.

Capitalization Rate = Net Operating Income (NOI) / Market Value of Property

Cash Flows

These numbers will look at how much money is being spent or generated on the investment property. Many investors prefer this method when they are deciding how to calculate ROI on rental property.

Cash On Cash Return

What is a good ROI on rental property? Cash on cash return can help a savvy investor decide. It’s a simple formula that compares how much pre-tax money is made on a rental property to the amount of cash money that was invested.

Cash on Cash Return (CoCROI) = Annual Cash Flow / Total Dollars Invested

Net Operating Income

Net operating income (NOI) is a simple calculation for investors to determine the profitability of a potential property. You simply subtract all the net operating expenses from the gross income to get the net operating income.

Pro Tip: NOI does not factor in any debt service or mortgage payments.

What Is A Good Rate Of Return On Rental Property?

Expected ROI On Rentals

The higher the percentage of return, the better. Rental property investments should yield more than enough to cover your expenses and make a profit.

The expected ROI on rentals depends on your market, but you should expect at least around 7.5% to make it worthwhile. If a property won’t give you that high of a return, then it might not be worth the investment.

Average ROI On Rentals

Rental properties yield about 10% ROI on average. This means that when you’re trying to decide between various properties and ROI calculations, you should land around 10% ROI.

What Is A Good ROI On Vacation Rental Property?

When you’re wondering what is a good ROI on vacation rental property, it’s important to look at all the factors. How long is the tourist season? Will there be months when the property will be completely empty?

You can typically get a higher ROI on vacation rentals because of the premium rates you can charge versus that of a typical rental home.

Takeaways On Calculating ROI Of Rental Properties

Rental property investment and investing in rental properties can mean two very different things. Flipping homes and wholesaling homes are much different business models than buying rental properties. What is a good ROI on rental property?

The one that leaves you feeling like your investment was worth the time and money. Most investors won’t purchase anything for less than 7.5% ROI and often look to make closer to 10%.

That said, the savviest investors are able to make double and triple-digit returns on both fix-and-flip and rental properties.

There are plenty of ways to calculate ROI on rental properties, so it’s critical to understand how each of the methods can serve you and your investment goals long-term.

Want to learn about wholesaling real estate? It’s a very different approach to buying and selling real estate. See how we help people all across the country wholesale houses from the comfort of their own homes in our free online training below!