There are a few investment options that match up to the potential of real estate. Once you have identified the right property, you can expect stable income flow, tax incentives, and property appreciation over the years.
However, despite its allure, an investor has the responsibility of ensuring the profitability of the rental property. You can’t leave it up to chance simply because you are maintaining the property, have a good rapport with the tenants, and collect the full rental amount every month. You must calculate the return on investment (ROI).
Sounds too technical? To help you understand the concept in its totality, the team from Evolve Nevada has put together this article.
What is ROI?
An abbreviation for return on investment, the ROI is a measure that will forecast or provide a look into the profitability of the investment.
What You Need to Calculate ROI for Rentals
ROI is typically used to calculate the profitability of rental investments. Before you can calculate ROI for a property, you will need a few details from the development:
- Property information - You will need details on the value of the property, the built-up area, and the rental amount. Some of this information might not be readily available. However, if an appraisal was done a few months back, this document should have all the information you seek on the property.
- Details on the loan - Information on the mortgage payment plan and other pertinent terms will be key to calculate the expense.
- Tenancy information - If the property is a multi-rental property, what is the expected vacancy rate? You might need to approach a local property expert for such information.
- Rental expenses - There are several elements to consider here. Some of the expenses to be added here include monthly maintenance, utilities, property management fees, and Homeowners Association (HOA) fees.
- Payment to third-parties - These are often one-time payments. Examples include rates to the local authorities, permits (e.g. fire), and landlord’s insurance.
With this information, you should be ready to progress to the next step. You will need to compute some vital figures before you are able to finally get the ROI of your investment property.
First is the Net Operating Income (NOI). Calculate the annual income from the property, from the rental income, parking, and other additional sources of income. This will give you the gross income. Add up the operating expenses and subtract them from the gross income.
A derivative of the NOI is the annual cash flow. This refers to the amount you stand to gain or lose after all expenses and the mortgage have been paid for. To calculate annual cash flow, subtract the debt from the net operating income.
Another important numerical figure is the Annual Gross Rent Multiplier (GRM). The GRM assists in you estimating the investment’s value. To find out the GRM, divide the annual gross income by the total sales price incurred to acquire the property.
To calculate the investment’s ROI, you will divide the net income by the amount it costs/will cost you to acquire the rental property. As a rule of thumb, an ROI of about 5 to 10% is a decent property return. If you get anything above 10%, that property is a must-buy.
However, we should note that the financial capability of each investor is different. You should also consider your budget, risk levels, and other investments should you want to diversify.
ROI for Sales
While it’s more commonly used for rental property, ROI can also be used by property investors interested in quick purchases and sales. In such scenarios, an investor will have the financial capability to complete the transactions without the help of a financier.
For example, an investor purchases a foreclosed property for $100,000 knowing that well-maintained properties in the neighborhood retail at $200,000. The investor repairs any property issues at a cost of $60,000, puts the property in the market, and makes the sale.
In such a scenario, the ROI would be calculated like: Net Profits ($200,000- 160,000)/ Original investment ($160,000) = 25%
The Importance of ROI
As a financial metric, the ROI is an important tool for any property investor. Firstly, it can help you understand the true potential of your rental. Once you have calculated the ROI, you can identify where you need to make the necessary changes to either increase the amount of rent or cut down on expenses.
ROI is an essential tool that can also help you make the final decision on which rental property to invest in. Say you have seen a few potential residential investment options in a neighborhood. How do you make the final selection? While there are a few items that will inform your decision, ROI should be included in the selection criteria.
Finally, ROI is key during the approval process by the mortgage lending company. The lender might be keen to know whether they will be able to recoup their investment through the property purchased. You might have a strong credit score and other financials to back you up but knowing the ROI will help as well.
Knowing your ROI is vital when investing in real estate. It can help you understand what you can afford, where to cut costs, what rent to charge and so much more. If you would like help calculating your ROI or managing your rentals reach out to a team of experts.
Evolve Nevada is a trusted property management company operating in Reno and Sparks, Nevada. We offer our clients professional service, customized to meet their needs. Our property management company is known throughout the region for its transparency, accountability, and exceptional customer service.
Are you looking for a property partner in Northern Nevada? Talk to Evolve Nevada today!