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Thinking Of Investing In A Rental Property Calculate Your ROI
It’s an age old question— “Where do I invest my money?” In addition to the classic mix of stocks, bonds and savings accounts, many investors diversify by investing in rental properties. The question for beginning Real Estate investors is, “how is that going to compare to other types of investments?” In other words, how can you calculate your return on investment [“ROI”] for a rental property?
Here’s a short calculation you can use to help gage if a particular property is going to be the right type of investment for your needs.
Let’s consider a hypothetical:
Jane has got $300,000 cash to invest in a property and is considering buying a condo in the same complex she lives in. This might make good sense— she can keep an eye on the property, rather than being an absentee landlord. She finds a unit for sale in the same complex for that amount. It’s 1,400 sq ft, has got 2 bedrooms and a number of nice upgrades. It’s move in ready and Jane isn't going to spend additional cash to fix up the unit.
So what factors are involved in determining the ROI?
A big question to ask is, what can I rent the unit for on a monthly basis? Your Realtor can help you calculate a competitive rent price per square foot and show you comps for similar rental properties in the area. That’s going to give you a good idea of what the unit could rent for. But a quick note about this— rents per square foot aren’t quite as tight as purchase prices per sq ft because appraisals and bank loans don't apply. As a landlord you may have much more flexibility in determining the rent.
The other key factor in our calculation is a careful consideration of the costs.
So let’s break this down and tally it together:
Jane is investing $300k cash for a 1,400 sq ft unit. We’ve seen rental rates in the complex of $1.23 per sq ft, so it seems likely she can rent the unit for $1,722 a month. In one year, the gross rental income will be $20,664.
Here are some of the possible costs she might encounter: Annual Taxes, Insurance and — the HOA fees all come out of the gross rental income. Let’s also add in an estimate for annual maintenance and repairs (e.g. broken dishwasher, leaky faucet, air conditioner tune-up, etc.). And, it’s a good idea to count on the unit being vacant about one month out of the year to be safe. That translates to an 8% reduction from the gross annual income.
Net Annual Income
Let's take these costs out of the Gross Annual Income: $20,663 - $2,025 - $700 - $3,230 - $1,000 - $1,653 = $12,056. Interesting— that’s considerably less than the $20k we started with.
Let’s then calculate the ROI with Net Annual Income divided by the Cash Investment.
That’s a 4% annual ROI using these numbers. One question to ask is if this is a good number compared to other investment instruments you may be considering.
The other item to consider is how will this property appreciate (or depreciate) in the future should the unit be sold? Nothing we’ve looked at here talks about the appreciation the property could have in addition to the earnings from the unit.
Plug in your own numbers…
If you’re interested in plugging in your own numbers and letting a spreadsheet do the math, just let me know and I’ll be happy to forward this along as a Google or Excel Document. Remember, I’m here to help.
Always consult your tax accountant when making an investment. Remember too that the real estate market is cyclical and real estate values go up and down. As with any investment, carefully consider the risks.
Thinking of investing in a rental property? Let me help you find the perfect Real Estate investment. Reach out and let’s work together.