Buying a new rental property often leads to the question, "how much can I rent my house for?" However, the answer to that question must also connect to your goals for return on investment (ROI). ROI helps investors analyze profitability, which is vital to paying ongoing operating expenses while building long-term wealth.
Without a consistently good ROI, you may not reach your financial goals for retirement, sending kids to college, or supplementing your full-time income. When buying a rental property through financing, how does the ROI calculation differ from paying cash-in-full for an investment? The best property management company Montgomery County offers helps property owners understand the critical difference!
How Does ROI for Cash vs. Financed Transactions Differ?
When calculating ROI for a cash-purchased rental property vs. financed rental properties, investors must remember to include interest for the mortgage. Interest is an added expense that doesn't apply to paying cash for a real estate investment. In many cases, closing costs are higher, and the closing process includes more fees than with a cash transaction. Cash-only ROI formulas are more straightforward, with fewer numbers to keep track of. However, many real estate investors use financing to buy new properties.
The calculation for ROI on Financed Transactions
A professional property management company can help you calculate the ROI for a financed transaction to make sure every cost makes it into the formula for an accurate profitability ratio. For example:
If your investment property costs $175,000, and you apply a $35,000 down payment, you're left with $140,000 to finance through a real estate investment mortgage. Then, you want to upgrade the property, and your remodeling costs are $9,000. Finally, closing costs come in at $7,000. At this stage, your total upfront out-of-pocket costs come to $51,000.
Next, you take out a 30-year loan on the property to finance that $140,000. If your interest rate is 3.5%, the monthly mortgage payment would be $402.
Next, we need to deduct any ongoing monthly expenses such as taxes and insurance. This amount might come to roughly $400 per month. Your new total for monthly expenses is $802.
After Expenses, Include Income
Rental property income is the next part of your calculation. In our example, we'll say you charge $1,500 per month for rent, giving you an annual income of $18,000. Once we subtract annual estimated costs ($802 x 12 = $9,624), you’re left with an annual net income of $8,376.
The last step is to divide the annual net income by how much you paid in upfront investment costs. This is the down payment and renovation expenses from earlier, or $51,000. Your finalized ROI calculation is as follows:
ROI: $8,376 ÷ $51,000 = 0.164.
Since the return on investment is a profitability ratio, convert this number to a percent by multiplying by 100. Now you have an ROI of 16.4%.
Keep in mind that if your ROI isn't what you want it to be, you can make adjustments. A Montgomery County property manager can give you a rental analysis to make sure you're charging the right monthly rent amount. A property management team can also recommend ways to cut expenses.
Home Equity and Its Role
As time goes on, you may not always be as concerned about knowing the answer to the question, "how much can I rent my house for," but rather, "how much can I sell my house for?" It's a good idea for real estate investors to know how equity plays a part in long-term financial success.
Equity consists of the money you have or can expect to have in the future from your investment. If you decide to sell the rental property, you know value is built into the home. At some point, you will have more value in the house than what you owe through what's left of the mortgage, meaning you have built equity through the investment. Property owners can see when that point will occur by looking at the amortization schedule.
To calculate how your equity affects ROI right now, you can follow these steps:
- Take the amount of your annual income and add the amount you put toward the principal. This is your new yearly profit.
- Now, to get an adjusted ROI, use the new annual profit number and divide by your upfront costs ($51,000).
- Multiply by 100 to get your percent.
This is an adjusted ROI that takes equity into consideration. However, if running these numbers is a frustrating process for you, work with property managers to keep track of profitability and operate your rental properties to meet your goals.
A Montgomery County Property Management Company Manages ROI
Making the most of your investments is a tall order! With the assistance of a property management company in Montgomery County, a property owner can sit back and relax while experts manage properties, renters, and your bottom line. Rentwell offers professional property management services to help investors maximize returns. Reach out soon to learn how we can help!
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