How to Calculate the ROI on A Property Investment
Real estate investing can be lucrative if you make thoughtful, data-informed decisions. The potential monthly income you can earn will help you boost your savings or pay down any debt you may have! In addition, your property will likely appreciate in value over time which will positively affect your return on investment (ROI).
Investing in real estate can seem daunting, especially if you don’t have experience in the industry. Many investors and landlords may not be aware of the responsibilities that come with property investments or how to ensure your investment property is lucrative.
Fortunately, the Leenan Property Management team are industry experts and have put together a guide below to help you determine whether your investments are viable!
Types of Rental Investments
There are various kinds of rental investments that you can choose from. Common options include single-family homes, townhomes, apartments, multi-family units, and duplexes.
The kind of property you choose to invest in should be influenced by your goals. Generally, landlords’ goals are tied to the profits they stand to make each month. That’s why it’s important to calculate the potential ROI of an investment prior to purchasing a property!
Important Information for ROI Calculations
Rental property investments aren’t all about appearances. A property may look promising, but it may not offer a good return on investment. So, how do you know whether a rental investment is worthwhile or not?
This is where calculating your return on investment (ROI) comes in. This metric measures how profitable a rental investment can be. You can find a list of important factors to consider when calculating your ROI below.
As you assess a property, it’s important to ask yourself the below questions:
- What is its property value?
- What does it cost to maintain it on a monthly or annual basis?
- What is its square footage and how many bedrooms and bathrooms does it have?
There is a lot to consider before taking out a mortgage. The following questions will help you determine whether taking out a mortgage is viable.
- What are the terms of the loan?
- How much was the down payment and interest rate?
- How much did the closing cost?
Landlords make most of their money from tenants’ rent payments. Consider the following when calculating your ROI
- What is the potential rental income on the property?
- Are there any other sources of income you will have access to aside from rental income?
Part of being a landlord is ensuring your property is in good shape. As this costs money, ask yourself the following before investing in a property.
- How much does it cost to maintain on a monthly basis?
- What kinds of repairs or upgrades do you expect to make?
- Are there any monthly HOA dues or other operational costs?
- How much does it cost to hire a property management company?
- How much will insurance and property taxes cost you annually?
Knowing these details will come in handy when it comes to choosing an investment that aligns with your financial goals.
Calculating the ROI on Your Investment Property
Once you’ve answered the above questions, you can start to calculate a property's potential ROI. The following are some of the important terms that you’ll need to familiarize yourself with first.
Net Operating Income
Net Operating Income (NOI) refers to all the income that a property generates, less the operational expenses. In other words, it refers to your take-home income.
NOI = Gross operating income – operating expenses
The capitalization rate is often called a cap rate. Using this calculation can help you obtain valuable insights that you can use to compare the rates of return on multiple investment properties.
The below formula, which divides the NOI by the property’s value will allow you to calculate a cap rate for an investment.
Cap Rate = NOI/Property Value
Generally, a property with a cap rate of 8-12% is considered viable. However, it’s important to remember that there are other factors to consider, such as location and property appreciation rates.
Cash on Cash Return
Cash on Cash Return is often referred to as CoC. This metric measures the amount of cash invested in a property versus the amount of cash flow it’s earning and is calculated on a pre-tax basis.
CoC = Annual Cash Flow/Initial Cash Investment) x 100%
This formula will help you determine how an investment will perform and whether the investment will be worthwhile. A cash on cash return of about 8-12% indicates a worthwhile investment according to most experts. For new investors, the returns might be lower but will increase as with experience.
Annual Gross Rent Multiplier
Also referred to as GRM, this calculation helps determine an investment’s value. It is the ratio of the price of a real estate investment relative to the potential rental income. However, it’s important to note that the GRM doesn’t factor in any operational expenses, such as utilities, insurance, and taxes.
To calculate the GRM, you’ll need to divide the property’s fair market value by the gross rental income.
GRM = Fair Market Value/Gross Rental Income
Suppose, for instance, that a property is selling at $150,000 and has a potential gross rental income of $24,000. Dividing the $150,000 by $24,000 would give a ratio of 6.25. The lower the GRM, the faster you’ll be able to pay off the property. Aiming for a GRM between 4 and 7 is usually a lucrative choice.
Annual Cash Flow
To calculate the annual cash flow, simply minus any debt from the net operating income. This will indicate how much profit or loss you can expect from your rental property.
Annual Cash Flow = Net Operating Income - Debt
Whether you’re looking for help calculating a return on your investment or need assistance with any other aspect of project management, Leenan Property Management can help!
We’re a professional property management company operating in both Regina and Saskatoon. We understand the ins and outs of localized real estate markets and are eager to help you make the right investment to achieve your financial goals!
Get in touch today to learn more!