Real estate investors purchase properties for many reasons. Some investors buy homes intending to rent them out, hoping to establish a steady source of income through rental revenue. Others purchase homes in a promising neighborhood,  invest in repairs and renovations, and sell the home for a later profit. 

Others might prefer to invest in a real estate investment trust (REIT) so they can avoid the hassles of the property management. No matter a property investor’s goals, real estate investors should always assess ROI before buying property.

Understanding ROI 

Return on investment or ROI is a useful statistic that serves as a basic indicator of an investment’s profitability, whether it be returns from stock or real estate investments. 

For its wide range of applications, the computation itself is not overly difficult to understand. A good investment probably has a net positive return on investment. 

However, these indications can help investors narrow their investment options if other investment opportunities with greater ROIs are available. We suggest investors also be aware of negative ROIs since they indicate a net loss. 

A property manager’s hands are pictured, using a white calculator to calculate the ROI of an investment property.

Here are the basics of what you’ll need to calculate the ROI: 

Cash flow

Cash flow is the amount of capital that remains each month from a rental property after all operating costs have been paid and funds have been set aside for potential repairs. 

Net Operating Income 

Net operating income, or NOI, is comparable to cash flow as it measures rental income less vacancy and operational costs. The main distinction between cash flow and NOI is that the latter does not take into account mortgage costs. 

Cap Rate

The expected rate of return on an investment property is referred to as the capitalization rate or cap rate. It’s comparable to a cash-on-cash return, except it doesn’t consider loan costs and it evaluates the cost of purchase instead of the cash you initially invested. 

Internal Rate of Return

The rate of return generated on an investment over a certain period of time is measured by the internal rate of return or IRR. It comprises cash flow as well as any gains from the sale of a property. IRR is the net cash flow and predicted property appreciation divided by the hold period. 

Annual Cash Flow

Debt is subtracted from net operating income to determine annual cash flow. The annual cash flow is measurable to the amount of profit or loss incurred by your rental property. 

How to Determine ROI for Rental Property 

Investment property owners are usually primarily concerned with cash flow or net income, which is calculated by deducting expenses from annual rental income. However, you’ll need to account for the additional costs associated with keeping a rental property. 

A cream interior of an apartment living room is pictured, with grey and cream marble floors, modern living room furniture, and a charcoal kitchen backsplash.

At the very least, additional costs cover insurance and property taxes. If you’re being prudent, you’ll also want to account for management fees and property repairs.  

Your investment property’s ROI can be calculated by dividing your annual return by the total cost of your investment.

The Importance of ROI for Real Estate 

Understanding the ROI of each investment helps you make smarter property investments. Estimate your costs, expenses, and rental income before making any purchases. Doing these calculations will help you measure your potential investment against other comparable homes.   

Calculating your ROI will also help you decide how to move forward with current investments. Is the property profitable? Should you sell your investment property? If you discover that your expenses will surpass your ROI at any point, this might be a smart move. 

Landlords find ROI useful for many purposes, including: 

  • Determining whether any positive return is occurring and where it comes from. 
  • Expanding their investment portfolio. 
  • Determining whether any properties are operating at a deficit.
  • Comparing monthly or yearly growth. 
  • Determining whether investing in property renovations is necessary. 

It’s important to understand how to calculate ROI for rental properties. It will be challenging to become the best possible investment property owner without knowing this information. 

Favorable Return on Investment for Landlords 

How much return on investment should a rental property have? Depending on your investment, the ROI might vary significantly. 

The most important thing to remember is that your ROI must be positive. A positive ROI indicates that you’re earning money, which is wonderful. Depending on your goal, you might or might not think your positive ROI is promising. 

Increase Returns on a Real Estate Investment 

To increase your investment property’s ROI, you can:

Maintain and Renovate your Property Regularly 

By maintaining and renovating your property, you’ll boost the infrastructure and worth of your property, which will naturally cause the value of your property to rise over time. Small things like repainting a wall or regularly cleaning the carpets will ultimately make a big difference for you and your tenants. 

Market Your Property to the Appropriate Demographic

Finding the ideal tenants for your rental property is a technique to minimize property vacancies. 

Lower Your Operating Expenses 

Spend time carefully examining your property’s expenses, from debt interest to property management fees. Cutting running expenses will give you a higher return on investment. 

Boost Tenant Retention 

Once you’ve found the ideal tenants for your rental home, you’ll want to make every effort to keep them. Maintaining tenants will guarantee you a steady income, which will increase your return on investment.  

Bottom Line: The Importance of ROI

Knowing the return on investment (ROI) for any investment, especially a rental property, helps you make informed decisions. We suggest considering several estimates, such as the fees and expenses, as well as your rental revenue. You can compare your findings to those of other properties.

After you’ve reduced your list of potential properties, pick the one that most closely matches your financial goals. 

Still have questions? Contact Keyrenter New England today at (643) 641-4000 for help with ROI or any of your property management needs.