Property rentals offer one of the best ways to diversify your portfolio and get a return on investment (ROI). They provide a steady income with the added benefit of appreciation over time. But with factors like property taxes, maintenance and insurance, determining the ROI on a rental property can be complex. In this article, we guide you on how to estimate the ROI of your rental property to help you assess profitability and make strategic financial decisions.
How to Calculate ROI on an Investment Property
ROI is a key metric for determining whether a property will yield a good return. Understanding what makes a good ROI for an investment property is not a one-size-fits-all process. The notion of a “good ROI” depends on factors such as location, market conditions and risk tolerance, some of which are not in the investor’s control. What one investor considers good may be subpar for another.
For example, some investors consider a 6% to 10% return on investment good. However, aggressive investors who rely on high-risk, high-reward strategies often aim to exceed the 10% ROI.
The ROI formula for rental properties involves three basic numbers. The net profit is divided by the total investment and then multiplied by 100.
Let’s say you have a single-family home and want to determine the probable ROI:
- You purchase a property for $250,000.
- The closing costs and the agent’s commission total $25,000.
- Insurance and property tax, plus other expenses, equal $5000 annually.
- The projected annual income is $30,000.
First, calculate the total investment, which will be the cost of the property plus the closing costs. The sum is $275,000.
Then, calculate the net profit by subtracting the annual expenses from the annual income. The answer is $25,000.
Now, divide the net profit by the total investment and multiply by 100.
ROI = (25,000/275,000) x 100 = 9.09%
With this example, you can expect a return of 9.09% annually. However, this percentage will look different depending on your financing option. The above example focuses on a cash purchase. But if you are leveraging debt, you may have a significantly lower upfront investment and a higher ROI.
Tips to Maximize ROI
Although ROI is subject to factors outside the investor’s control, like market conditions, you can implement several methods to improve your ROI.
- Optimize rental income: Make strategic property upgrades and add amenities that justify higher rent.
- Minimize vacancies: Invest in real estate marketing services to increase your property’s exposure.
- Partner with a property management company: Work with a professional company with the resources and experience to help you adhere to legal requirements and increase your property’s appeal.
- Invest in a tenant experience: Host events to foster community and be responsive to tenant requests.
Choose Elevated Management Group, LLC
As a leading property management company in New Mexico, we offer our clients local expertise backed by years of experience. From marketing to rent collection and mortgage payments, every aspect of your rental property will be in good hands.
Contact us to get started with renting out your property.
