One of the main reasons people get into investing is to build generational wealth. Whether you put money into stocks, bonds, or real estate, the long-term goal is to achieve a positive ROI (return on investment) on your initial investment.
Unlike stocks and bonds, one of the unique features of investing in real estate is that it’s tangible, a physical item you can see and hold. There are many ways you can go about it. You can take a hands-on approach by flipping and renting, or a more “passive” way by participating in REIGs or purchasing REITs.
Regardless of your intentions, the goal stays the same, achieving a positive ROI. In today’s article, we will be discussing how to calculate your ROI, specifically if you’re looking to rent.
Main Takeaways
- Return on investment (ROI) quantifies the amount of money or profit earned on investment as a percentage of the investment’s cost.
- All the money you put into the house, including your downpayment and any other repairs, needs to be considered when calculating your ROI.
ROI = Gain on Investment – Cost / Initial Cost of Investment
Calculating your ROI
Calculating your ROI is simple enough; you take the gains from your investment and subtract them by the cost. Then you divide by the initial cost.
When calculating the initial cost, ensure you put all the money you put into the house, including your downpayment, closing cost, and any other repairs.
Example A: Paid in Cash
- You paid $150,000 for the property.
- To close on the house, you spend $5,000 on closing costs and an additional $5,000 to make the house rent ready. Your total initial investment is now $160,000.
- You rent out the unit for $1,200 per month.
12 months later
- You have collected $14,400 in rent.
- Maintenance, insurance, and taxes added up to $2,000 for that year.
Annual Profit = $14,400-$2,000 = $12,400
You then divide $12,400 with your intial cost.
ROI = $12,400 / $160,000 = 0.0775 (7.75%)
Your ROI for example A is 7.75%.
Example B: Financing
- Your downpayment is $30,000 with the closing cost at $6,000
- The house needed $5,000 in repairs.
- Your initial cost is now $41,000
Calculating cost
- Your mortgage payment is $500 per month ($6,000 per year)
- Maintenance, insurance, and taxes added up to $2,000 for that year.
- Your yearly cost is $8,000
12 months later
- You have collected $1,000 per month as rent ($12,000 per year)
Annual Profit = $12,000-$8,000 = $4,000
You then divide $4,000 with your intial cost.
ROI = $4,000 / $41,000 = 0.0975 (9.75%)
Factors You Have To Consider
Naturally, extra expenditures associated with owning a rental property, such as repairs and maintenance, would need to be factored into the calculations, therefore altering the ROI. Certain items like an HVAC system blowing out needs to be calculated in your cost. If you buy an older house, consider purchasing a home warranty to cover some of the blow.
Additionally, we assumed that the home was rented for the whole calendar year. In many situations, particularly between renters, vacancies occur, and you must account for the loss of revenue during those months in your calculations.
Conclusion
Calculating your ROI isn’t hard as long as you keep track of everything you spend on the property and keep tabs on all the revenue you collect. With single-family homes, it’s simple. Most of the time, you will only collect monthly rent, but when you start expanding to apartments and other commercial properties. You may begin charging for parking passes and additional fees.
On the other hand, the more cash paid upfront and the less borrowed, the lower your return on investment, as your original cost will be larger. In other words, financing enables you to increase your return on investment (ROI) in the short term by lowering your upfront cost.