What's the ROI for your rental property? If it's not a question you've considered yet, it's time to learn about the importance of return on investment (ROI) and how to calculate it!
This article provides our expert Philadelphia property management tips on calculating ROI for rental properties and applying that metric to the performance of an investment. Keep reading to learn what ROI is and how the formula differs if you've purchased a property with cash vs. financing.
What Is Return On Investment?
ROI is a calculation used to measure the profitability of an investment compared to the costs to own and operate it. While this calculation can apply to almost any type of investment, it's critical for rental property owners, as well. Analyzing ROI is important when considering a potential investment, as well as monitoring the performance of rental properties you currently own.
It's important to remember that while your property can generate a profit every month, that's not necessarily the same as being profitable. ROI helps investors determine the overall profitability of a rental home and how it aligns with long-term goals.
When analyzing a potential investment, estimating ongoing costs vs. the question of "how much can I rent my house for" can help you determine if the property will generate the returns you need after purchase. With your current properties, checking the ROI from time to time helps you determine if a property is performing well or if you need to make changes to improve returns. Conversely, a consistently low ROI can indicate that a property isn't worth any additional investments dollars, and it could be time to sell.
What's the ROI Formula?
To find a property's ROI, investors must take the initial purchase price for the property (including closing costs and renovations to get the property ready to rent) and subtract it from the annual revenue to determine the annual profit. Then, divide the profit by the costs to get the ROI.
For example, when paying cash for a new investment:
- You pay $130,000 for a new rental property in Philadelphia
- Closing costs and initial renovations add another $15,000 to the startup costs, which now total $145,000
- The monthly rent amount is $1,300, which means the annual revenue is $15,600
- Ongoing operating expenses (property taxes, utilities, insurance, etc.) are $300 per month )or $3,600 for the year
- The total annual return is the revenue minus ongoing costs, or $12,000 ($15,600-$3,600)
With these numbers in mind, calculate the ROI:
- Divide the annual return ($12,000) by the total investment amount ($145,000)
- The ROI is .0827. Shown as a profitability ratio, it is 8.27%
Is that a good ROI? It depends! Many property management experts recommend targeting an ROI of 10%, but a "good" ROI depends on your property and goals. If you'd like to see a higher return on investment, work with a property management company to reduce costs or analyze the rent rate (or both) to improve profitability).
What About a Financed Transaction?
Taking out a mortgage on an investment property is common. If you haven't paid cash in full for a Philadelphia rental property, that's okay! Make adjustments in your calculations to account for the different types of transactions, then manage your property to achieve the ROI you need.
Analyzing ROI for a financed purchase requires incorporating any costs included in a monthly mortgage payment. So, when a property owner calculates the ongoing operational expenses, they must include the monthly mortgage payment amount and note whether that payment includes escrow for property taxes or insurance (to avoid double-counting those expenses).
What Do Property Managers Say Affects ROI?
When mentioned working with a property manager to improve ROI, but what affects your returns? Expenses and income are the two primary drivers of return on investment, and both can be adjusted to improve profitability—with the right experience and insights!
Property managers know how to help an owner reduce maintenance costs, find quality tenants who pay the rent on time, and find the ideal rental rate. The combination of reduced costs and optimal monthly income (paid on time) helps property owners experience better returns.
It can be difficult to think of spending money on a property manager to improve returns. However, most real estate investors find that partnering with one of the best property management companies is an excellent investment that helps boost returns while minimizing the "hands-on" work an owner has to do!
Maximize Returns With a Philadelphia Property Management Company
ROI (Return on Investment) is a term that investors in the real estate industry use to evaluate profitability and understand if they're making money. To calculate ROI, you need accurate numbers for costs and income. If your property's ROI ratio falls below what you expected when evaluating it, work with a Philadelphia property manager to improve its performance!
At Rentwell, we want our clients' properties to be profitable to meet their long-term goals! Reach out today to learn more about how our property management services can help you maximize return on investment.
Ready to learn about your property's ROI? Try our free resource, Calculate the ROI For Your Rental Property.