How to Calculate ROI on a Rental Property

How to Calculate ROI on a Rental Property

How to Calculate ROI on a Rental Property : To grow their wealth is one of the key motivations for investing. Making money is typically the foundation of all investments, despite the fact that individual investors may have different goals—some may want money for retirement, while others may decide to set aside money for other life events like having a child or getting married. Furthermore, it makes no difference where you invest your money—in real estate, bonds, or the stock market.

Real estate is material property composed of land, usually comprising any resources or buildings on the ground. One type of real estate investment is an investment property. Typically, investors buy homes with the goal of earning money from rental revenue.

What Is Return on Investment (ROI)?

The amount of money, or profit, made on an investment is expressed as a percentage of the investment’s cost, and this is known as return on investment. It demonstrates how profit is made from investments successfully and efficiently. Understanding return on investment (ROI) enables investors to determine if making a given investment is a smart move or not.

Any investment, including stocks, bonds, savings accounts, and real estate, can be measured using return on investment. It can be difficult to determine a significant return on investment (ROI) for a residential property because formulas are easily adjusted to include or remove specific elements. When investors can choose to pay with cash or by taking out a mortgage on the property, things can get really complicated.

Here, we’ll go over two instances of calculating return on investment (ROI) for residential rental property: a cash purchase and one that is mortgage-financed.

The Formula for ROI

Any investment’s profit or gain can be determined by deducting the initial cost from the overall return on the investment.

​For instance, if you buy ABC stock for $1,000 and sell it two years later for $1,600, the net profit is $600 ($1,600 – $1,000). ROI on the stock is 60% [$600 (net profit) ÷ $1,000 (cost) = 0.60].

Calculating ROI on Rental Properties

When purchasing a property with cash, figuring out the return on investment is quite simple. Here’s an illustration of a cash purchase of a rental property:

  • Cash was used to purchase the rental property from you.
  • Your entire investment for the home was $110,000, including $1,000 for closing costs and $9,000 for renovating.
  • Each month, you received $1,000 in rent.

A year later:

  • During those twelve months, you received $12,000 in rental income.
  • The annual cost of the insurance, property taxes, and water bill came to $2,400. or $200 a month.
  • $9,600 was your yearly return ($12,000 – $2,400).

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To calculate the property’s ROI:

  • The whole investment, or $110,000, is divided by the annual return of $9,600.
  • ROI is equal to $9,600 ÷ $110,000, or 8.7%.
  • It was an 8.7% ROI for you.

Unlike other assets, the return on investment (ROI) of a rental property varies significantly based on the financing method (cash or mortgage). Generally speaking, a smaller down payment on a house will result in a larger mortgage loan total but a higher return on investment.