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Are you wondering if your property investment is truly profitable? Calculating the Return on Investment (ROI) is the best way to get a clear picture of how well your rental property is performing.
For landlords, knowing your ROI isn’t just a numbers game — it’s a key to smarter decision-making, better financial planning, and maximizing long-term profit. This guide will walk you through simple yet effective methods to calculate ROI, from basic formulas to more detailed calculations.
By the end of this guide, you’ll have the knowledge you need to make confident choices about your property investments and grow a successful rental portfolio.
Types of Rental Properties: Short-Term vs. Long-Term Investments
Before diving into ROI calculations, it’s essential to understand the types of rental properties. Your strategy may vary depending on whether you own a long-term or short-term rental property. Each type has unique profit potential and ROI considerations.
Long-Term Rental Properties
Long-term rental properties are leased to tenants for extended periods, typically several months to years. Examples include residential homes, apartments, and commercial units. With long-term rentals, landlords enjoy consistent rental income and the possibility of property value appreciation over time.
For long-term rentals, a solid ROI typically ranges from 8% to 12% annually. Factors like location, market trends, operating costs, and the efficiency of property management significantly affect ROI.
Short-Term Rental Properties
Short-term rentals are properties rented for shorter periods, often less than 30 days. Platforms like Airbnb and VRBO have made short-term rentals a popular option for homeowners.
These properties generate income during peak seasons but may experience slower revenue in off-peak periods. For short-term rentals, an attractive ROI is usually around 10%, but during peak seasons, it could be as high as 20%.
The return largely depends on the property’s location, local tourism trends, and the quality of property management.
3 Essential Ways to Calculate ROI on Rental Properties
To make smart investment decisions, it’s vital to know how to calculate ROI. Here are three common methods that landlords can use to assess their property’s profitability.
1. Simple ROI Formula
The simplest way to calculate ROI is to compare your investment’s total income with its overall cost. Here’s the basic formula:
ROI = (Income from Investment - Cost of Investment) / Cost of Investment
Example: You buy a rental property for $100,000 and generate $120,000 in total profit. The ROI is:
ROI = ($120,000 - $100,000) / $100,000 = 0.2 or 20%
This method provides a quick view of profitability, but it doesn't factor in operating costs, so it’s best for a general overview.
2. Capitalization Rate (Cap Rate) Calculation
The Cap Rate is a popular method for evaluating profitability, especially for long-term investments. Unlike the simple ROI formula, it accounts for ongoing operating expenses. The Cap Rate formula is:
Net Operating Income (NOI) = Rental Income - Operating Expenses
Cap Rate = (NOI / Property Purchase Price) x 100%
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Example: You purchase a rental for $200,000, with $1,500 in closing costs and $10,000 for renovations, bringing the total cost to $211,500. If your annual rental income is $12,000 and annual expenses are $2,000, your NOI is $10,000.
Cap Rate = ($10,000 / $211,500) x 100% = 4.73%
Investors generally aim for a cap rate between 8% and 12%, but this depends on the local real estate market and investment goals.
3. Cash-on-Cash Return (CoC) Calculation
Cash-on-Cash Return (CoC) is especially useful for properties purchased with loans. It shows the return on actual cash invested rather than the property’s entire cost. Here’s the formula:
CoC = (Annual Cash Flow / Total Cash Invested) x 100%
Example: You buy a $200,000 property with a 20% down payment of $40,000. Closing costs are $3,500, and renovations cost $10,000, bringing your total investment to $53,500. If you earn $1,500 monthly in rent but pay $1,000 in mortgage expenses, your monthly cash flow is $500, or $6,000 annually.
CoC = ($6,000 / $53,500) x 100% = 11.2%
For landlords using loans, the CoC method gives a clear picture of the cash return compared to out-of-pocket expenses.
What’s Considered a “Good” ROI on a Property?
What’s considered a good ROI depends on your investment strategy, property type, and location. Here’s a general guideline:
Simple ROI: 15% or higher is generally considered favorable.
Cap Rate: 8-12% is common for long-term rentals.
Cash-on-Cash Return: 8-12% is seen as a solid benchmark.
The 1% Rule: A Quick Screening Tool
The “1% Rule” is a simple way for landlords to quickly assess potential rental properties. It suggests that the monthly rent should equal at least 1% of the property’s purchase price.
While this rule is a good starting point, it’s not foolproof. It doesn’t account for property expenses, taxes, or local market conditions. Some properties may meet the 1% rule but have higher maintenance costs that reduce profitability.
How to Improve Your ROI
Minimize Operating Costs: Reduce maintenance and repair expenses by scheduling preventive maintenance.
Increase Rent Strategically: Make small upgrades that justify higher rent, such as modern appliances or energy-efficient upgrades.
Efficient Property Management: Hire professional property managers to reduce vacancy rates and improve tenant satisfaction.
Refinance Your Mortgage: Lowering interest rates on loans can reduce monthly mortgage payments, increasing cash flow.
Final Thoughts
Calculating the ROI on your rental property is a smart move for any landlord. It gives you a clear view of your property’s profitability and helps you make better financial decisions.
Whether you prefer the simplicity of the ROI formula, the precision of the cap rate, or the depth of cash-on-cash return, each method provides valuable insights. But managing rental properties can be time-consuming and complex.
That’s where SGI Property Management Phoenix comes in. With expert support, we handle the hard work for you, maximizing your ROI while you enjoy stress-free property ownership. Let SGI make your investment truly pay off!
