Calculating the ROI of a Rental Property

Calculating the ROI of a Rental Property
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Along with the management consulting and social media work, I also invest in residential rental properties. It is important to know how to calculate if a property will be profitable and what the return on investment (ROI) will be. The first thing you should know is if you are Value or Cash Flow investing.

Value Investing is when the primary purpose of purchasing a property is to hold it with the hope that the value of the property will increase. Purchasing a property in a high growth area for $100k and selling it a few years later for $500k would be an example of this. With these properties, it is okay to just break even with rental income.

Cash Flow Investing is when the primary purpose of purchasing the property is to make money through rental income. All costs considered, your rental income should be high enough that you can consider it income.

Of course, the ideal case would be that you find a property that falls within both parameters. That can be hard depending on where you are located and how much capital you have.

For the purpose of this post, we will be focusing on Cash Flow Investing.

Now let’s get into calculating if a property is profitable if you are financing the property.

Firstly, let’s go over all of the costs that you have to consider initially and then on an ongoing monthly basis of owning a rental property.

Out of Pocket Cost:

Initially, you would have to consider how much money you have to put down to purchase the property. Usually, it can be anywhere from 5-20% depending on your credit and the type of property. Let’s say you are purchasing a property that is worth $150,000 and have to put down 20% ($30,000). You also have to consider closing costs. For this example, closing costs are $10,000 for calculation purposes. Another cost that you usually have to pay that most people don’t consider is the following year’s property taxes. Say that property taxes for this property are $10,000 per year.

In total, the initial cost of purchasing this property will be $50,000. Meaning you will need this cash on hand right off the bat to purchase this property.

EDIT: I forgot to add Inspection costs. I have seen them range from $500-$2,000 depending on the property size and location. For this blog post, I will keep the math the same, but be aware that it is usually mandatory to have an inspection done.

Ongoing costs:

Now it is time to calculate what your costs will be on a monthly basis. Continuing with the example from above, we will have to finance $120,000. People usually pick between financing over 15 or 30 years. We will finance over 30 years here. For investment properties, the interest rate is around 7% or 8%. We will use 8% to be conservative. You can use many online tools to calculate your monthly mortgage costs. Google search Mortgage calculator.

The monthly mortgage cost alone will be $880.52 per month on the $120,000 over 30 years at an 8% interest rate.

Next, you will have to also factor in the property taxes for the next year into your calculation as well as a Landlord Insurance Policy. Our property taxes for this property is $10,000 and let’s say the insurance policy is $2,000 per year.

The total monthly cost of this property is $1,880.52.

Other hidden costs to consider:

-In some cases, if you put less than 20% down you will be charged what is called PMI. PMI stands for Private Mortgage Insurance and you will have to add this to the monthly mortgage cost if needed. I have seen it being anywhere between $150-$300 per month.

Common Charges: Some properties charge common charges to maintain the property (cutting the grass, snow removal, pools, etc.). These costs will also need to be considered on a monthly basis. The price of common charges really depends on the type of property and where it is located.

Is it profitable for Cash Flow Investing:

Now its time to do some research on the average rental costs in the area. Look on Zillow and other sites like it to see what the rental prices are for properties on the same block/building and in nearby locations.

If the average rental is $2,400 in the area, this may be a good Cash Flow property.

If it is $1,900 or below, I would not consider it for cash flow.

I usually only choose properties that can generate a monthly return of $600 or more, but it is based on personal preference.

Calculating simple ROI:

For rental properties that you have financed, it is good to calculate your return on investment.

For the purposes of this example, our monthly cash flow from the property is $500 per month (rental income minus ongoing monthly charges). This would result in an annual return of $6,000 ($500 x 12 months) from rental income after all costs.

If the out of pocket cost (initial cost) of purchasing the property is still $50,000, our ROI will be calculated as follows:

$6,000 (annual cash flow) ÷ $50,000 = 12% ROI

This formula can get very complex as some people use an amortization table to also factor in the principal (mortgage) paydown. I would say that a 12% simple ROI is very good. It would take roughly 8 years to break even on your initial investment ($50k/$6k).

I would also suggest reading the book HOLD: How to find, buy and, rent houses for wealth by Steve Chader if you are considering residential real estate investments.

You can also find other great books to read in one of my older posts called Essential Business Reads.

I hope you guys enjoyed this post. More will be coming soon! Until next time…

 

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Top 10: Business Apps

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 We live in a digital world. I think we have all heard this before, but the statement does hold true. These days technology is the primary driver in creating an efficient workspace. In this post, I want to share the mobile applications (in no particular order) that have saved me the most time and money (my two favorite things) in business.
 
1.    CudaSign (formerly SignNow) – CudaSign allows you to attach legally binding e-signatures to documents right from your phone. After opening your files in CudaSign, you can E-sign and add dates anywhere on the document. Once you finish, create PDFs and send them back out within minutes of receiving the original files. This app will cost you a whopping $1, but for the time it has saved me, I would have paid more.
2.    TurboScan – I don’t think I can explain to you how many times this app has saved me. There have been times when the Internet has gone out in the office or I was on the road where I needed to scan and send documents. TurboScan enables you to take high-resolution pictures of your work right from your phone. It also has a simple editing tool that allows you perfect your “scans” before you send them out as PDFs.
3.    Mortgage Calculator Plus – For those of you in the real estate space, this app is essential. It’s always important to understand the costs of obtaining a property, and in my case, if it will be profitable. Mortgage Calculator Plus allows you to easily calculate your potential monthly mortgage while considering all other costs associated with purchasing the property. In the investment real estate industry, this will help you save time by weeding out properties where the math just doesn’t add up.
4.    Mint – Whether you use it for your business or personal finances, Mint is a great tool to track your income and expenses. The app enables you to add various online accounts (checking, saving, credit card, stock, retirement, etc.) and organizes all the information in one place. Always keep a close eye on your money. Money can’t always buy you peace of mind, but if you save enough, it can buy you a Bentley.
5.    Audible – I can’t remember the last time that I actually had the time to sit and read a book. Therefore, I began listening to audiobooks instead, because knowledge is power, right? With audible, you can listen to your favorite books from your phone while on the go (driving, flying, at the gym, etc.). Ps: Keep an eye out for my next post about my all time favorite business reads.
6.    WhatsApp – Ladies and gentlemen, WhatsApp has become the new BBM. If you have business either locally or abroad, this is the app is for you. Not only can you text internationally for free, but you can now make wifi calls too. Most people I have spoken to in a business or personal capacity use WhatsApp regularly, especially internationally.
7.    Square – This is the only app on the list that I do not personally own, but have experienced via clients. If you are selling products or services for your small business, Square is the app for you. After downloading the app and signing up on their website, Square will send you a free magstripe that will allow you to make sales right from your phone. Coming from an accounting background, I like square because you can easily import your sales information into QuickBooks or any other accounting software. Some would say the 2.75% cost per swipe is too high, but I think that its simplicity and ease make up for it.
*The last 3 apps are specifically for my travelers out there. These apps will save you money and help organize your itinerary.
8.    TripIt – Don’t you find it annoying to fish through all your emails for flight and rental confirmation numbers? I did. TripIt will organize all of your traveling plans in one place. It takes your flight, rental & hotel order confirmation emails (without you doing anything) and arranges your whole trip from beginning to end.
9.    Skipplagged – This app has a very interesting history. The founder of the app was sued by various airlines and travel websites due to his unconventional and genius way of saving money on flights. The idea is that sometimes booking more flights will result in cheaper tickets. For example, let’s say you wanted to go to Chicago from New York. Skiplagged will book you a flight for North Dakota where your destination is actually the connection site (ie Chicago). The idea is that a connecting flight to North Dakota from New York is actually cheaper than a direct flight to Chicago (I just made this scenario up, so maybe it isn’t, but you get the point). The catch is that you can’t check in your bags, so use this for your short trips only.
10.    Hotel Tonight – The last app on the list has to do with booking hotels. There are many hotels out there that actually offer discounts if you book within a day or two. Hotel Tonight will find you these hotels, as well as break them out into categories (Lux, Basic, Hip, Solid, etc.). So if you need to take a last minute business trip, you don’t always have to pay an arm or a leg for a nice hotel room.

I hope you all enjoyed my first post. What apps do you use? Look out for my next post on my favorite business books!

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You’ll get our newsletter containing additional information about how to better your Startup business in areas like Managment, Marketing, Finance, Funding, Time-Management, Leadership and more. We are here to help!

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