How to calculate the real ROI of your rental property investment
Investing in rental properties can be an excellent way to build long-term wealth and passive income. However, accurately calculating your real return on investment (ROI) is crucial to determine if a rental property is a good investment. The real ROI accounts for all the costs associated with owning the property. Here’s how to calculate it:
Calculate your gross rental income
First, calculate your total potential gross rental income for the year. Take the monthly rent for the property and multiply it by 12 months to get your annual rental income. Be sure to factor in any months where you expect the property to be vacant and not generate income.
Determine your operating expenses
Next, calculate all of your annual operating expenses. This includes property taxes, insurance, HOA fees, regular maintenance, repairs, property management fees, utilities, and any other costs associated with running the rental. Be thorough, as underestimating expenses will skew your calculations.
Find your net operating income
Take your gross rental income and subtract your total annual operating expenses. This gives you your net operating income (NOI).
Additional reading: Rental Yield
Factor in your mortgage payments
If you have a mortgage on the property, subtract your total annual mortgage payments (principal + interest) from the NOI. This gives your before-tax cash flow.
Calculate your cash-on-cash return
Take your before-tax cash flow and divide it by the total amount of cash you initially invested in the property (down payment + closing costs). This percentage shows your cash-on-cash return.
Determine your capitalization rate
Divide your NOI by the property’s total purchase price. This calculates your cap rate. Generally, a higher cap rate means a better return.
Consider tax implications
Consult with your accountant about tax deductions and obligations to find your after-tax cash flow. This is your real ROI.
Accurately calculating your rental property’s real ROI helps you evaluate if it’s a good investment for your financial goals. Follow these steps annually to maximize returns.
