As a property owner, what is a good rate of return on a rental property business? With so many terminologies and figures to keep tabs on, keeping track of your profits can become a challenge. Even seasoned investors with money coming in and out of several properties might struggle to determine which of their properties is performing poorly or excellently.
Before we get into the nitty-gritty of how to determine your rate of return, we highly recommend you hire a property manager to assist you with your business. These highly-skilled professionals can help monitor your expenses and track your income, which you’ll need to determine a property’s performance.
How to Calculate ROI
Calculating your property’s ROI might seem intimidating, but it’s pretty easy if you have the right numbers. Some of the details you might need include the property, mortgage, rental income, and monthly expenses. Once you have these crucial figures, you can either input them into an online ROI calculator or use one of the following methods:
- Net Operating Income (NOI): This figure represents your total income less your operating expenses. While it measures your net revenue, it is only the basis for determining rental property success.
- Capitalization Rate: Cap rate is a popular metric in the real estate market because it accurately compares different investments. You may calculate it by dividing your NOI by the property price. The higher your cap rate, the more reward you stand to gain, but it also means the more risk you bear.
- Cash-on-cash Return: You calculate your cash-on-cash return by dividing your NOI by the amount spent on acquiring a property. It represents the relative value of your investment.
- Annual Cash Flow: For a yearly projection of your property’s profit, deduct your debt from your NOI. This metric is the best for investors in hidden real estate investment opportunities like house flipping.
What is a Good Rate of Return
As an investor, after calculating your ROI, the next question you should ask yourself is, what does this figure mean? In other words, if you have a cash-on-cash return of 20% on a $100,000 SFU, is that good or bad? Unfortunately, there isn’t a single answer to that question. Different investors have their benchmarks for the success or failure of their property. An ROI of 9% might be ideal for a risk-averse landlord, considering their investment is newer and stands to appreciate over time.
However, an excellent judge of your property’s performance is the rate of return on similar properties in nearby neighborhoods. If you’re not satisfied with your property’s performance, you might have to evaluate some of the factors affecting your ROI.
Factors that Can Affect the Rate of Return
Calculating your net operating income means deducting your rental expenses from your rental income. In other words, the higher the cost of maintaining your rental property, the lower your yield. These expenses may fall into one of two categories: fixed fees such as insurance and property taxes; and variable costs like repairs.
Another factor that can affect your rate of return is your taxes. For example, property taxes are fees owners pay on their houses. This fee varies from one county to the next and one property type to the other. In other words, if you have identical SFUs in different neighborhoods, one might yield a higher return than the other because of local taxes. Also, if you’re not filing your taxes correctly, you could be losing out on the opportunity to include valuable deductibles.
Most landlords rarely pay out of pocket and rely on other means of financing their investment. Conventional bank or private loans incur interest which adds to your rental expenses. Although mortgage fees are tax-deductible, they’re still a considerable cost to consider and can even make investing in real estate impossible. Simply put, lower interest rates encourage more investors to join the market, which means an increase in returns.
Weather and climate often play a role in the rate of return for many investors. Warmer seasons like spring and summer are more likely to encourage prospective tenants to get out of their houses and look for other options. However, vacancies tend to peak around winter, when most people would rather stay put wherever they are. Thus, such extended vacancies can weigh down your monthly rate of return as the weather cools.
Knowing what a good rate of return on a rental property business is essential to ensure your investments are performing well. Without a proper record of your ongoing expenses and income, calculating your ROI by any means would be extremely tedious. Consequently, it would be next to impossible to determine the success of your business or what factors might be affecting your return rates. However, hiring a property manager can ease your landlord’s journey by helping you analyze your returns and maximize your investments.
- Baker, Dean. 2007 Housing bubble update: 10 economic indicators to watch. Center for Economic and Policy Research, 2007.