Are you up to speed on the metrics you need to evaluate real estate investing success? Calculating a property's ROI is not the same as finding out "how much can I rent my house for." Although this information factors into the calculation, there is more that goes into understanding ROI. Our Tri-State property management advisors are here to break it down for you, with today's focus on how to determine the ROI for cash transactions.
Why Is ROI Important?
Before we get too far, it's a good idea to discuss why ROI (or return on investment) is so important to an investor. This may seem like an obvious answer, but your ROI determines the profitability of an investment. For example, you may find a property that you believe will generate a high monthly income, but that doesn't tell you the ROI or factor in your profits after analyzing income vs. costs. Understanding ROI gets down to the bare bones of what you will have left once those other factors are analyzed.
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Understanding Terminology
Before we get to the formula, let's start with some basic terms that can be helpful to know when reviewing ROI cash transactions. These are:
- Earnings gained: How much rental income you generate.
- Cost of investment. This includes the cost of the property, any upgrades you make, plus the ongoing monthly expenses.
- Net profit. How much the profit is after deducting the cost of the investment.
- Profitability ratio. This is the percentage used to express your ROI.
With these terms, we'll next talk about a cash transaction vs. a financed investment.
What Is a Cash Transaction?
A cash transaction simply means that an investor paid for the property with cash upfront without any financing to buy the investment. Cash transactions make figuring out the ROI less complicated than factoring in a mortgage payment and other startup costs for a rental property. While not every investor has the cash capital to invest in a property, it's important to understand the ROI for cash-only purchases.
The Calculation for ROI on a Cash Transaction
When determining the ROI for a cash transaction, investors need to add up all the money (cash) you put into the home upfront. This includes the cost of the property and any upgrades. Next, add the monthly expenses you'll have for the property, such as property taxes and landlord insurance.
For example, if you paid $200,000 in cash for the property and put out $10,000 in remodeling, your initial up-front cost is $210,000. If you have $100 a month in utility costs or property management fees to one of the best Tri-State property management companies, you would add another $1,200 to the investment cost, bringing your total cost for the investment to $211,200.
Next, calculate the rent every month and figure out the annual amount. For example, if you charge $1,500 a month, the yearly rental income amount would be $18,000. Now that you have your total costs and income, it's time to calculate the ROI!
- The first step is to subtract the annual rent from the total cost of the investment ($211,200 - $18,000 = $193,200).
- Next, divide the answer by the total cost of the investment. ($193,200 ÷ $211,200 = 0.91
- Since ROI is a profitability ratio, take one more step to make this number into a percentage. Simply multiply 0.91 by 100, and you will have 9.1%.
Your ROI for this cash real estate investment transaction is 9.1%.
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How To Know If a Property Has a Good ROI
Now that you've calculated your ROI, is it good enough? Is it high, low, or just right? A property manager would say that between 8–12% is a good return on investment, with 8% being on the low side and 12% being a generous ROI. If you aim for a 10% return on a rental property, you should be in the safe zone and on your way to building more long-term wealth!
However, if you find that your property is not bringing in 8%, property managers recommend doing a few things to improve it. Investors can adjust the monthly rent by increasing it or cutting down on some costs. If you currently cover utilities, consider switching those expenses to your renters instead of including an estimated amount in the monthly rent. Working with a property management company is also an excellent way to reduce maintenance expenses, optimize rental rates, reduce vacancies, and improve returns!
Connect With a Tri-State Property Management Company to Manage ROIs
Managing returns for rental properties can be challenging without the right resources or experience. However, rental property owners can work with one of the top property management companies in the tri-state area to improve ROI and build a profitable real estate investment portfolio! At Rentwell, our professional property management services help investors stay on the right track with ROIs and more. Connect with us for more information about how full-service property management can help!
