Residential real estate; the simple math behind a sound investment plan

How to Calculate ROI on Rental Properties

how to calculate ROI on rental property

Owning a rental property can be an excellent way to create a passive income stream. Before you buy, however, it’s helpful to know how to calculate ROI on a rental property to make sure it’s a smart investment. There’s more than one way to determine a rental property’s expected ROI when gauging how profitable it’s likely to be.

What Is ROI for Rental Property?

ROI stands for return on investment. Put simply, it is how much money you make (or lose) on any investment.

The ROI for a rental property represents how much income the property produces versus the amount of money you invest in maintaining it.

If you’re interested in owning rental property for passive income, ROI is an important consideration. Failing to perform an ROI calculation means going in blind, which is never a good idea.

It’s also helpful to perform ROI calculations on a rolling basis once you own a rental property to estimate your profit margin. When inflation pushes up the cost of maintenance, for example, that can directly affect your bottom line.

How to Calculate ROI on Rental Property

how to calculate ROI on rental property

The simplest way to calculate ROI on a rental property is to subtract annual operating costs from annual rental income and divide the total by the mortgage value. However, there are some other calculations you can use to determine how much of a return you might expect when investing in a specific property.

Cash Flow ROI Calculation

Cash flow properties generate a steady stream of cash each month after operating expenses are paid. The cash flow ROI calculation is fairly straightforward:

Gross rent – Expenses = Cash flow

Operating expenses for rental property can include things like marketing or advertising while the property is vacant, property management services if you’re hiring someone else to oversee the property, repairs, maintenance, property taxes and insurance.

The cash flow ROI calculation tells you how much money you can expect to pocket monthly from a rental property, based purely on what comes in and what goes out.

Cash-on-Cash Return

Cash-on-cash return measures a rental property’s annual cash flow based on the amount of cash invested. Here’s how to find cash-on-cash return for a rental property:

Annual cash flow / Total cash invested x 100 = Cash-on-cash return

This ROI calculation is typically used to gauge how well a rental property might perform over a given year, based on how much cash you invest in it.

Cap Rate

The cap rate or capitalization rate for a rental property is the estimated rate of return. To find the cap rate, you’d divide the net operating income of a property by its purchase price.

Net operating income / Purchase price x 100 = Cap rate

The lower the cap rate, the lower the risk while a higher cap rate can suggest that a rental property is a riskier investment.

Net Operating Income

Net operating income or NOI is the difference between the rental income a property generates and what you pay for operating expenses and vacancy losses. Here’s how to find NOI for a rental property:

Rental income – Operating expenses – Vacancy losses = NOI

NOI measures profitability based solely on operating expenses and vacancy losses. This calculation does not include mortgage expenses if you’ve taken out a loan to purchase the property.

You might use NOI to calculate ROI on a rental property if you’re comparing multiple properties since you don’t need mortgage details to make the calculations.

What Is the 2% Rule in Real Estate?

The 2% rule in real estate is another simple way to calculate ROI for rental properties. According to this rule, if the monthly rent for a rental property is at least 2% of its purchase price, then odds are it should generate positive cash flow.

The calculation for the 2% rule looks like this:

Monthly rent / Purchase price x 100 = X

In this case, X represents the percentage you get after completing the calculation. If you do the calculation and get 2% or higher, then the property is likely to produce positive cash flow. On the other hand, if you get a number below 2% then the property may not be profitable.

how to calculate ROI on rental property

Just as there’s no single option for how to calculate ROI on a rental property, there’s no set-in-stone number that translates to a good rate of return. The reason is that there are a variety of factors that can influence the returns a property generates, including:

  • Purchase price
  • Mortgage costs, including your down payment, closing costs and monthly payments
  • Rental income
  • Occupancy and vacancy rates
  • Operating expenses

When gauging what is a good rate of return for a rental property, it’s important to consider your specific goals and objectives. For example, you might have a baseline ROI or cash flow target that you’re hoping to reach monthly or annually.

Looking at the rate of return in that context can help you to evaluate prospective investments and find ones that are most likely to align with both your goals and risk tolerance. It’s also important to consider overall demand and market conditions in the area where you’re shopping for rental properties.

Rental housing is something people will still need, even if the economy weakens or slips into a depression. However, a changing economic landscape may see demand for rental properties cooling in the hottest or most expensive markets. High inflation can also shrink profit margins if you’re spending more to maintain the property.

The Bottom Line

Knowing how to calculate ROI on a rental property can be invaluable when you’re searching for the right properties to invest in. Running multiple calculations using different formulas can offer varying perspectives on how much profit you might expect to see. You can then compare those numbers to the returns you’re hoping to see in order to decide if a property is a good match.

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28 thoughts on “Residential real estate; the simple math behind a sound investment plan

  1. The Treasury Market’s Big Recession Trade Is Gathering Momentum
    Michael MacKenzie

    (Bloomberg) — The bond market is zeroing in on a US recession next year, with traders betting that the longer-term trajectory for interest rates will be down even as the Federal Reserve is still busy raising its policy rate.

    Long-dated Treasury yields are already below the Fed’s overnight benchmark range — currently 3.75% to 4% — and there’s still an extra percentage point of central bank increases priced in for the coming months. Activity has also emerged in the options market that suggests some are hedging against the risk that policy rates could eventually halve from their current level.

    Rather than wait for conclusive economic evidence that this year’s frenetic monetary tightening will deliver recessionary conditions in 2023, investors have been buying bonds — a stance advocated by Pacific Investment Management Co., among others.

    “Fed policy is dynamic and they are still signaling they are going to go higher,” said Gregory Faranello, head of US rates trading and strategy at AmeriVet Securities. “But the market trades like it is more comfortable with the Fed getting to an end game.”

    Demand for Treasuries with longer tenors this week dragged the rate on 10-year and 30-year securities below the lower bound of the Fed’s overnight range. With front-end rates holding relatively steady, that’s seen an intensification of the most pronounced yield curve inversion in four decades — a widely watched indicator of potential economic pain to come.

    “The recession indicator narrative is strong, but from the Fed’s perspective it is part of the solution,” said Faranello.

    The US economy — and in particular the labor market — has so far shown itself to be quite resilient in the face of Fed rate increases, which are aimed at trying to curb high and seemingly persistent inflation. Investors will therefore be keenly attuned to the monthly jobs report this coming Friday for signs of cracking, or indications about whether it might pave the way for the Fed to tweak its policy course.

    They’ll be scrutinizing carefully the words of Fed Chair Jerome Powell and his colleagues, who will speak publicly next week for the last time before heading into the customary blackout period ahead of the Fed’s Dec. 13-14 policy meeting. While minutes of their most recent meeting showed that they’re likely to slow the pace of tightening soon, officials have been firm in reiterating the need for policy rates to move above current levels.

    At this stage of the cycle, Fed jawboning may prove less effective than the tone of data, given expectations of a gradual slowing of policy tightening from here amid a conviction that inflation has peaked and job creation is slowing.

    The scale of bullishness in the long-end of the bond market right now — and the depth of the yield curve inversion — means that there could be some turbulence for Treasuries as traders navigate a range of top-tier data in the coming week, not just the jobs report. Recession bets could find succor from a forecast contraction in the ISM manufacturing gauge, while the personal income and spending report will show how things are evolving on personal consumption expenditure, the Fed’s preferred gauge of inflation. Figures on the number of job openings are also scheduled for release.

    Current swap-market pricing shows the effective fed funds rate rising to around 5% by the middle of next year, followed by a pullback that takes it more than half a percentage point lower by early 2024. But some are betting on a much sharper reversal, with trades this week tied to Secured Overnight Financing Rate futures focused on the possibility of a decline to 3% or even 2% by either the end of 2023 or early 2024.

    That said, there is resistance in some quarters to the current bond market consensus about the Fed, the economy and of course the eventual return of low inflation next year. This week Goldman Sachs Group Inc. said the 10-year will trade above 4% through to 2024 as expectations for rate cuts next year are dashed by the economy not entering a recession and inflation remaining high.

    That’s far from the central view though. Market pricing is suggesting that even if the Fed itself is not yet pivoting on policy, many investors are increasingly turning their eyes away from the risk of relentless Fed hikes and toward a possible economic slump.

    What to Watch

    Economic calendar:
    Nov. 28: Dallas Fed manufacturing activity index
    Nov. 29: Conference Board consumer confidence; FHFA house price index
    Nov. 30: ADP employment; MBA mortgage applications; third-quarter gross domestic product; advance goods trade balance; wholesale and retail inventories; MNI Chicago purchasing managers index; pending home sales; JOLTS jobs openings; Fed beige book
    Dec. 01: Personal income and spending report, including PCE; weekly jobless claims; ISM manufacturing
    Dec. 02: Monthly jobs report
    Fed calendar:
    Nov. 28: New York Fed’s John Williams; St. Louis Fed’s James Bullard
    Nov. 30: Chair Jerome Powell; Governors Lisa Cook and Michelle Bowman
    Dec. 01: Vice Chair for Supervision Michael Barr; Dallas Fed’s Lorie Logan; Bowman
    Dec. 02: Chicago Fed’s Charles Evans
    Auction calendar:
    Nov. 28: 13-week and 26-week bills
    Nov. 29: 52-week bills
    Nov. 30: 17-week bills
    Dec. 01: 4-week, 8-week bills
    ©2022 Bloomberg L.P.

    https://www.bloomberg.com/news/articles/2022-11-26/the-treasury-market-s-big-recession-trade-is-gathering-momentum

  2. When you use these methods for calculating ROI do you count loan closing costs and property taxes separately from the mortgage value or would those be considered separately?

    1. As you can see from reading the article, I just cut and pasted an article from Smart Assets and left all the original links in the article. My intention was to illustrate the different types of financial equations an investor MUST be aware of when determining the validity of an investment property choice. With this said, there are better sources out there for illustrating specific instances with each mathematical ratio or equation. Although I normally stick to discussing two ratios that are used by commercial real estate investors (e.g. cap rate and internal rate of return), I also can figure out in my head what my return on investment (ROI) would be. For many investors this value will vary depending on their strategy. For instance, an investor may pay cash for a property and then turn around and finance it with a cash out after it is rented. Obviously, the ROI will vary over time.

      For a clearer illustration, I cut and paste an example from Investopedia below, which illustrates and helps to answer your question. For rental properties I always deduct property taxes from gross cash flow whether financed or not.

      When I consider a rental property ROI with a mortgage payment, I only use the principal and interest component for the monthly expense. I don’t consider escrow as I would have to pay that anyway, whether it comes out in a monthly mortgage payment or a lump sum every year.

      One more thought regarding closing costs. I’ve noticed that investors tend to treat closing costs differently. Some include them and some don’t. It also depends on your investment experience and time horizon. I can see an instance where a closing cost would not be included, for a rental property owner while they would be included for a flipper. Essentially, closing costs become less of a concern the longer you own the property. It’s kind of a one-off thing versus property taxes which are annual. In addition, your closing costs couldn’t be much different than someone else’s on the same property. It all depends on your circumstances and time horizon. I tend to minimize the usage of closing costs when I calculate my ROI. When it comes to cash out financing transactions I just roll the closing costs into the mortgage itself.

      For me, I add closing costs to my cost basis. The closing costs for my last transaction we’re only about $3,000. If I had financed the transaction, it probably would have been about $15,000. If I can roll the closing costs into the mortgage then it’s the total mortgage amount with closing costs included.

      _______

      https://www.investopedia.com/articles/investing/062215/how-calculate-roi-rental-property.asp

      ROI for Financed Transactions

      Calculating the ROI on financed transactions is more involved.

      For example, assume you bought the same $100,000 rental property as above, but instead of paying cash, you took out a mortgage.

      The downpayment needed for the mortgage was 20% of the purchase price, or $20,000 ($100,000 sales price x 20%).

      Closing costs were higher, which is typical for a mortgage, totaling $2,500 upfront.

      You paid $9,000 for remodeling.
      Your total out-of-pocket expenses were $31,500 ($20,000 + $2,500 + $9,000).
      There are also ongoing costs with a mortgage:

      Let’s assume you took out a 30-year loan with a fixed 4% interest rate. On the borrowed $80,000, the monthly principal and interest payment would be $381.93.

      We’ll add the same $200 per month to cover water, taxes, and insurance, making your total monthly payment $581.93.

      Rental income of $1,000 per month totals $12,000 for the year.

      Monthly cash flow is $418.07 ($1,000 rent – $581.93 mortgage payment).
      One year later:

      You earned $12,000 in total rental income for the year at $1,000 per month.
      Your annual return was $5,016.84 ($418.07 x 12 months).

      To calculate the property’s ROI:

      Divide the annual return by your original out-of-pocket expenses (the downpayment of $20,000, closing costs of $2,500, and remodeling for $9,000) to determine ROI.
      ROI = $5,016.84 ÷ $31,500 = 0.159.
      Your ROI is 15.9%.

      1. I looked at network TV today at a friend’s house for Thanksgiving dinner and since I don’t have cable, I decided to look at the commercials and observe the races of people portrayed on each commercial. I looked at a couple business shows and parts of two football games.

        Here were the percent of commercials by race:

        Total commercials observed: 27

        White: 22% (6)
        Black: 56% (15)
        Other: 22% (6)

        Nothing unusual. Demoralization campaigns against the majority are the most effective when the majority doesn’t realize there is a demoralization campaign. Those who pose no threat to the New World Order are overly represented at the expense of those who do pose the threat.

        1. I can’t help noticing that there are many more blacks and colored foreigners being represented in ads.
          In addition, the ads are representing many gays, lesbians, transgender, etc. Clearly there is a demoralization campaign going on against traditional Christian values and against whites in general perpetrated by those working for satan.

          1. It’s really mind blowing at how deceived the church has become. It’s really mind blowing and how deceive the alt-media has become. Virtually from stem to stern. They really do embrace the last days iron and clay of Daniel. They run around and claim to know so much about eschatology and yet they all fell victim to Satan. Hook, line, and sinker. They are all deceived.

          2. Everything I’m discussing on this site is coming all together perfectly like a finely tuned Swiss watch and I’m the only one for some reason who can actually see it all happen in real time. I marvel at the ostensibly pious people in the Christian church who are being deceived and I observe how all of the races, colors, and creeds are all being deceived, all simultaneously. They’re all under hypnosis. They don’t know the OT prophets. They’re not bright enough anymore. They just don’t know.

            The end.

  3. A divided Fed hides behind fuzzy language -Reuters

    Nov 24 (Reuters Breakingviews) – The Federal Reserve does not quite know when to stop hiking interest rates. A key question for investors wagering trillions of dollars on bonds and currencies is what the U.S. “terminal” rate is – the resting place for this cycle of monetary tightening. Those hoping for a clue from the central bank, however, have found themselves debating the meaning of “various”.

    The word appeared in the minutes for the November meeting of the Fed, which were released on Wednesday. “Various” members of the 12-strong Federal Open Market Committee, the document said, noted that their assessment of the ultimate rate “was somewhat higher than they had previously expected.”

    That could signal bigger rate rises ahead. The problem is that “various” is not in the informal, and carefully studied, glossary the Fed uses to telegraph its decisions to the market, unlike expressions like “almost all” or “most”, making the message hard to read. The choice of words looks deliberate, given the huge uncertainty around the U.S. economy. But it means that economists and traders parsing Fedspeak for a living will be left guessing just how many officials favour a terminal rate above the 5%-5.25% currently expected by the market. The Federal Reserve itself seems equally uncertain.

  4. Oil is struggling here, not because of some European price caps, but because the chart and market action have been dictating it. The charts and market action tell me that oil is struggling, and the Business Media look for an excuse. But the ostensible cause and effect are murky to say the least. The price of oil has been struggling here and I suspect that given the reduced influence of Joe Biden’s energy policies in the wake of the Republicans taking the house, I suspect oil will continue to struggle and we will eventually see $65 a barrel.

    Keep in mind that oil was selling for below $50 a barrel for years before covid and actually turned negative on the spot market as there was hardly any excess capacity of storage left.

    I suspect that if the Republicans lost the house as well, the green energy policies of the Biden regime would have been another sucker Punch to the oil and gas industries here in the states. OPEC can cut as much production as they claim they are going to, and it won’t matter in the longer run. The chart and market action are telling me that the prices are going lower.

  5. Russia’s parliament passes law banning ‘LGBT propaganda’ among adults

    https://www.reuters.com/world/russias-parliament-passes-law-banning-lgbt-propaganda-among-adults-2022-11-24/

    ing ban on promoting “LGBT propaganda” to children by banning it among people of all ages.

    Under the new law any event or act regarded as an attempt to promote homosexuality – including online, in film, books, advertising or in public – could incur a heavy fine.

    The fine will be up to 400,000 roubles ($6,600) for individuals and up to 5 million roubles ($82,100) for legal entities. Foreigners could face 15 days of arrest and subsequent expulsion from the country.

    Critics see the move as an attempt to further intimidate and oppress sexual minorities in Russia, where authorities have already used existing laws to stop gay pride marches and detain gay rights activists.

    Lawmakers say they are defending morality in the face of what they argue are “un-Russian” decadent values promoted by the West. But human rights groups say the moves are designed to outlaw representation of minorities such as lesbians, gay men, bisexuals and transgender people (LGBT) in public life.

    “LGBT today is an element of hybrid warfare and in this hybrid warfare we must protect our values, our society and our children,” Alexander Khinstein, one of the bill’s architects, said last month.

    LGBT Network, which offers legal aid, has called the legislation an “absurd” attempt to humiliate and discriminate against the LGBT community.

    TikTok, a video-sharing app, was fined 3 million roubles last month for promoting “videos with LGBT themes”, while Russia’s media regulator asked publishing houses to look at withdrawing all books containing “LGBT propaganda” from sale.

    The bill needs to be reviewed by parliament’s upper house and signed by President Vladimir Putin before coming into force.

  6. Interest rate cut possible if economy demands, says Bank policymaker

    https://www.theguardian.com/business/2022/nov/24/interest-rate-cut-possible-if-economy-demands-says-bank-of-england-policymaker-dave-ramsden

    Interest rates may need to start falling again if cost of living pressures abate more quickly than the Bank of England expects, a senior policymaker at Threadneedle Street has said.

    Dave Ramsden, one of the Bank’s deputy governors, said he was currently supporting fresh increases in the cost of borrowing but raised the possibility that a weakening economy may require a cut.

    “Given the uncertainties we face it is important also to be humble about what we don’t know or still have to learn. I favour a watchful and responsive approach to setting policy,” Ramsden said.

    “Although my bias is towards further tightening, if the economy develops differently to my expectation and persistence in inflation stops being a concern, then I would consider the case for reducing Bank rate, as appropriate.”

    Ramsden’s comments came as the latest snapshot of manufacturing from the CBI predicted Britain’s factories were facing a tough winter.

  7. After 5 billion people received the mRNA gene therapy deathjabs of covid, every illness is now an imminent threat.
    ________

    Measles is an ‘imminent threat’ around the world, CDC and WHO report finds

    Measles is an “imminent threat” around the world, according to a new joint report released Wednesday by the Centers for Disease Control and Prevention and the World Health Organization.

    https://abcnews.go.com/Health/measles-imminent-threat-worldwide-cdc-report-finds/story?id=93857891

    1. Most hospitals in medium and large cities are building “cancer wings.” These are huge investments, engaged after the research of markets. How does this industry know that the business will be there?

  8. I like to give Thanks for this website. Apostle Paul talks about Christian fellowship. This website is a great forum for likeminded unwashed people to get together as we are being increasingly isolated by brainwashed people who are on a road to eternal torment.
    Fellowship is getting more necessary as we Christians get increasingly isolated by satanic influenced people that make up the majority. This site has really helped alleviate my loneliness in this satanic world.

    In addition this website is great at keeping a balanced perspective on the economy and geopolitical events.

  9. CJ Evans I wish you a wonderful Thanksgiving. I also wish Tom Beecham a wonderful Thanksgiving as well.
    I am thankful for discovering the real spirit of Jesus Christ in May of 1994. I am thankful for my willingness to study and understand the Bible. I can only understand what is happening in the world today by aligning my heart with Jesus Christ and studying the Bible. Otherwise, I would have lost my way along with most of humanity today. Only through Jesus Christ do I have peace of mind.

    When I say study the Bible I mean the WHOLE Bible. It is necessary to study the Old Testament as well as the New Testament. Each Testament enhances the other.

    I don’t approve of New Age theories, however it helped me appreciate that their is a spiritual world as well as a physical world. Today’s churches really fail big time to teach about the spiritual world where God and satan operate. The spiritual world impacts activities in the physical world. My childhood church failed to teach about the connection of both the spiritual and physical. This failure results in many turning away from the church and turning to false new age teaching.

    I am also thankful for being prudent, responsible, and staying in the stock market unlike a few of my family members who are now broke. Do all you can to rein in your spending and buy income producing assets.

    Only faith in God helped me climb the wall of worry when stocks crashed in March of 2020 and in September.

    1. Yes, thank you, sir. I appreciate the effort and the no-nonsense take on what we are up against. Have a terrific Thanksgiving!

  10. I want to wish all my readers a wonderful and Happy Thanksgiving. The God of Abraham, Isaac, and Jacob blessed America with many blessings and it was a non-conditional promise made on Jacob’s deathbed to his son Joseph. Ephraim and Manasseh, the British Commonwealth and the United States received a double portion for the last days. The synagogue of Satan has tried mightily to water down these birthright promises and destroy the prophecy. Regardless of how many false flags and terror attacks are perpetrated against the remnant here in the states, the prophecy is unfolding, and Jacob is still intact. God bless the remnant in the name of Jesus Christ.

    I will be 57 in a couple of weeks and my life has never been better. I have amazing health and I continue to prosper. Once I stopped struggling with my demons, the God of Shem and Noah through his son Jesus has protected me. The power of our father is incalculable. I believe that during the second Exodus our adversary won’t be able to touch us.

    Pray ceaselessly and ask for divine protection. Thank the God of our fathers for all that he has done for us and ask for those who are struggling to find renewed strength and vigor as we hurtle toward the last day.

    May you have a wonderful and prosperous Thanksgiving and may the God of Abraham, Isaac, and Jacob bless you and keep you, and may his face shine upon you, and may He grant you peace in Jesus’s name. Amen.

      1. Thank God for drawing you to his Son, Chris. For giving you peace, health, and security. He is our Prince of Peace.

        May you also have a wonderful and prosperous Thanksgiving and may the God of Abraham, Isaac, and Jacob bless you and keep you as well, and may his face shine upon you, and may He grant you peace in Jesus’s name. Amen.

    1. Really appreciate your making your insights and analysis available through this site — and bringing the Old Testament to life. May the God of Abraham, Isaac & Jacob also continue blessing and guiding you

    2. I wish everyone who posts on this site a happy Thanksgiving today. While the world is falling apart morally and socially, be thankful to the Lord for all the blessings you have. Be thankful there is still time to make hay and get your spiritual house in order. Be thankful for your financial and physical well being.

      God bless every poster on this site for making positive and insightful contributions.

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