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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Essential Business Reads

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Welcome back, it’s time for another FBS blog post! Listed below are a few of my favorite business books (in no particular order). These books have provided me with inspiration, knowledge, and positivity. All things that I believe are essential in anyone’s life. Although these books are business related, I truly believe that anyone can read them and learn a lot.

 

First on the list is The E-Myth Revisited  by Michael E. Gerber. Gerber speaks about why most small businesses fail and what to do about it. The author explains how every business needs three skill sets: 1. The entrepreneur (the dreamer and visionary), 2. The manager (the organizer) and 3. The technician (the worker). The technicians, who love what they do, decides to start a company on their own instead of making someone else rich (great!). Now the reason that this business will most likely fail is due to micromanaging by the technician (not so great). They will want to make sure everything is done the way they have always done it. Gerber explains the issue here and expands on what corrective action should be taken. It is a great book for anyone thinking of opening his or her own business. The E-Myth will teach you lessons that you would most likely learn the hard way.
The 4 Hour Workweek: Escape the 9-5, Live Anywhere, and Join the New Rich (Expanded and Updated) by Timothy Ferriss (what a title) may catch you off guard as you read it. Some of the things he preaches seem a bit outlandish at first, but will eventually strike a cord. The book is split into four sections: 1. Defining your goal and figuring out what you really want (and for those of you who cannot decide, he helps you figure it out), 2. Eliminate your distractions by learning how to be effective instead of just efficient, 3. Automate your cash flow, resulting in an increase of income and finally, 4. Liberate yourself by increasing mobility. He speaks about how he went from monotonously working for someone else for 40 hours a week to starting his own business and working 80 hours a week. The 4 Hour Workweek tells you the story of how he eventually transformed his life to working just a few hours a week while also making money and enjoying life. This book will inspire you to take charge of your life. If you work at a deadbeat job that doesn’t appreciate your work or if you are struggling to live your life while running your own business, The 4 Hour Workweek is for you.
Rich Dad Poor Dad by Robert Kiyosaki is one of the first business books I ever heard about. A friend introduced it to me when I was unsure of where my professional life would take me after college. It is the story of the author and a comparison of his “rich dad” and “poor dad.” It just so happens that his biological father, who has a doctorate, went to Ivy League universities, believes in working hard and saving money was the “poor dad.” Who would have thought? All the while, his “rich dad” (his friend’s father) who dropped out of school in the eighth grade builds an entrepreneurial empire by using his financial literacy and street smarts. Kiyosaki walks you through his life experiences to offer you a new perspective. Some people have criticized him about whether he was completely truthful in his book, but his message is loud and clear no matter what. I still believe that this book is a must read for anyone.
Black Swan: The Impact of the Highly Improbable. No, this is not the movie with Natalie Portman and Mila Kunis. This is a book by Nassim Nicholas Taleb, the essayist, scholar, statistician and risk analyst. The book dives into how unpredictable severe events are and how people underestimate their significance. These events are referred to as Black Swans. The three attributes that define Black Swan events are those that are irregular, have an extreme impact, and are eventually explainable (only in hindsight). Taleb’s writing style is very smooth and easy to read. You really feel like you are there with him when he explains some of his life stories. The Sunday Times even placed the Black Swan among the 12 most influential books after WWII.
Hold: How to Find, Buy, and Rent Houses for Wealth by Steve Chader is my usual real estate plug-in. Hold is the opposite of a get rich quick book, rather it focus’ on how one can create a lifetime of wealth through rental real estate investments. The book also comes along with downloadable content that puts the book into better perspective. As some of you know, along with business consulting, I have been heavily involved with rental real estate properties for years. This book has played an important role in my recent real estate knowledge while also continuing to offer inspiration.
Crucial Conversations: Tools for Talking When Stakes Are High by Kerry Patterson, Joseph Grenny, Al Switzler and Ron McMillan explains a skill that is very important in business, communication. In work settings, it is not uncommon that you will come across a number of critical conversations. Whether this be about a raise, a business deal or even heated conversations with a business partner it is vital for you to know how to approach the subject. I have experienced instances at my old jobs where tensions were high due to deadlines and cooler minds have prevailed. This book goes over certain techniques that will allow you to have a leg up in these instances.

This will likely be the beginning of a series as I have learned so many things from business books. I chose the above reads for this post as they cover a variety of topics. It is important to read inspirational books that spread positivity when working at the conventional job or owning your own business. They will motivate you to do better by providing a new perspective. Who knows, a book can be the final push that will change your life forever.

I will now leave you with a quote that I like from Oscar Wilde,

 

 “Anyone who lives within their means suffers from a lack of imagination.

 

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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