Rental Property Calculator
Use our rental property calculator to calculate the financials and potential return on investment for a rental property purchase.
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How to Calculate Rental Property ROI
Rental properties can be a great way to generate passive income and build wealth over time. Before purchasing a rental property, it’s important to understand how to calculate your potential return on investment (ROI) or potential loss.
ROI is a metric for evaluating the profitability of an investment, and it’s often used to evaluate the potential for rental property investments. There are several metrics used to measure the ROI for a rental property, including cash flow, cap rate, cash on cash return, and the gross rent multiplier.
You can calculate these metrics using formulas, but you need to gather some preliminary information about the property first.
The first set of information you’ll need to put together is the cost to purchase and finance the property. The purchase price, down payment, and monthly loan payments will all be needed to evaluate the ROI of a rental property.
You’ll also need to do some research to determine the rental income that the property can generate each month. You can look at what other comparable properties in the area rent for to help determine this.
It’s also important to consider the vacancy rate when doing this research. Do you expect the property to be rented for short or long periods of time, and when it does become vacant, do you expect to find a new tenant quickly, or will it take a long time?
This determines the effective gross rent that the property can generate each year, which is ultimately what you need to estimate the property’s cash flow.
When renting a property, there will be several recurring expenses that you’ll need to account for. You’ll need to understand the costs of ownership for the property, as well as the cost of operating the property as a rental.
Some expenses, such as property management fees and utilities, are only paid when the unit is rented, while others, such as HOA dues, property taxes, and insurance, are due regardless of vacancy.
Most property management companies charge a fee as a percentage of the rental income, but they can help collect rent and locate tenants to fill the property. They also coordinate maintenance and tenant complaints or requests.
You’ll also need to consider common maintenance and repairs that may be needed for the property. Maintenance may include things like yard work, landscaping, and snow removal.
Repairs include fixing things that break, such as plumbing or appliances. Depending on the condition and age of the property, the amount of repairs may vary widely.
Net Operating Income
Net operating income (NOI) is one metric used to determine the profitability of a real estate investment. Net operating income is the income generated after accounting for operating expenses.
Net operating income is essentially a measure of the cash flow for the property, and you can calculate it using the following formula:
net operating income = gross income – vacancy loss – operating expenses
Thus, net operating income is equal to the gross income generated minus losses due to vacancy minus operating expenses.
Cap rate, or capitalization rate, is essentially the rate of return for an investment property. The cap rate is a ratio of a property’s annual net operating income relative to its market value, expressed as a percentage.
It’s used to evaluate the income generated relative to the property value, and is a reasonably good measure for comparing the profit potential for different investment properties.
You can calculate the cap rate using the following formula:
cap rate = net operating income / property value × 100%
The cap rate is equal to the net operating income divided by the market value, expressed as a percentage.
Cash on Cash Return
Cash on cash return is another metric used to evaluate the rate of return and profitability of an investment property. Cash on cash return is a ratio of the cash flow to the total cash invested in a property, expressed as a percentage.
This metric is used to evaluate whether a property can generate a positive cash flow and is worth the cash needed to invest.
You can calculate the cash on cash return using this formula:
cash on cash return = annual pre-tax cash flow / total cash investment
The cash on cash return is equal to the annual pre-tax cash flow divided by the total cash investment, expressed as a percentage.
Gross Rent Multiplier
The gross rent multiplier (GRM) is another metric used to determine a property’s potential return on investment. The gross rent multiplier is a ratio of the property value or purchase price to its annual gross rental income.
You can calculate the gross rent multiplier using the formula below.
gross rent multiplier = property value / gross annual income
The gross rent multiplier is equal to the property’s value divided by the gross income generated by the property.
When evaluating whether to invest in a rental property, there are several other factors to consider. One significant factor is the tax implications of the investment.
You can depreciate the property as a capital expense, but you’ll need to determine the taxes due for the profits generated. Most often, the largest tax hit is incurred when selling an investment property, so it’s wise to plan accordingly.
The appreciation rate of properties in the market is also an important factor to keep in mind. In many cases, real estate will increase in value over time and property is often worth more in the future as time passes.
You can use our appreciation calculator to calculate the future value of the property.
Another factor to consider when evaluating a property investment is the terms on the loan.
During periods when interest rates are high, this means loans are more costly, and monthly payments will be higher. It may make sense to make a more sizable down payment or pay off higher-interest mortgages early.
On the other hand, when interest rates are very low, the loan payments are much smaller, and it may make more sense to incur more debt to acquire the property.
It’s also important to consider the rental market in the area, your ability to operate the property, the loan to value for the mortgage, and the outlook on the housing market and wider economy as a whole.
Frequently Asked Questions
How much profit should you make on a rental property?
The profit you should expect to make on a rental property varies based on the rental market and other various factors. However, in general, a profit of 10% or greater is considered good. In addition, an ROI of 5% to 10% would still be considered a good investment, but less than 5% would not.
What is zero cash flow property?
A zero cash flow property is a property that does not produce any cash flow to the owner in a given year. This means that the property’s operating income and expenses plus debt obligations are the same, meaning there is no free cash flow left over.
Is it OK to break even on rental?
Whether breaking even in cash flow on a rental property in a given year is OK for an investor is a personal choice for each investor. If the investor is solely focused on cash flow, they would not move forward with the investment.
However, if the investor is looking to build equity in the investment property, the tenant is still paying down the mortgage and increasing the owner’s equity in the long run. The property could also appreciate over time even if it is breaking even each year, allowing the property owner to earn a profit when they sell.
How do you know if a rental property is profitable?
Using the formulas above and determining the ROI of a rental property will help determine if it is an investment that a potential buyer wants to move forward with.
There are also other things to consider to determine if a rental property will be profitable in the long run, such as the location of the property, property taxes, school district, local crime, other rentals in the area, average rent price in the area, and the state of the overall rental market and economy.