Return on Investment (ROI) 

When evaluating an investment property, using rental metrics and analytics is crucial for making informed decisions. Metrics provide a clear picture of a property’s current or potential financial performance, helping investors gauge profitability and mitigate risks. ROI is one metric that can help investors optimize their portfolios, ensuring they make the most out of their real estate ventures. 

What Is ROI? 

As the name suggests, return on investment (ROI) is a measure of an investment’s profit yield or return. In real estate, ROI is the percentage of return generated by a rental property relative to the cost of the initial investment. It is one of the most fundamental metrics used in rental property investing. 

Calculating a precise ROI before making an investment is impossible, but you can still make reasonable estimates that can encourage or deter you from certain properties.  

ROI Formula 

The formula for calculating ROI is as follows: 

ROI (%) = (Annual Return / Cost of Initial Investment) * 100 

As you can see, there are two main parts to the formula: Annual return and cost of initial investment. 

Annual return is essentially the gain on the investment minus the cost of the investment. An investment’s gain is equivalent to its rental income here, while its cost includes debt service (your mortgage and interest payments) as well as regular operating expenses required to maintain the property, such as insurance, property taxes, and others: 

Annual return = Annual rental income – (debt service + annual operating expenses) 

The result that you ultimately yield after inputting these values into the ROI formula is the percentage of profit or loss you will earn on your property relative to your initial investment over a one-year period. It’s worth noting that using annual return means that ROI is a 12-month assessment of your property’s potential worth.  

When To Use ROI 

ROI can paint a picture of your rental property investments’ efficacy. It is best to use ROI when you are venturing into a new real estate investment, though it can also be helpful in determining whether an ongoing investment is consistently worth the time, money, or effort you are putting into it. For instance, it can help you determine which variables in your investments are not having significant effects on your return. 

Additionally, it’s best to use ROI in coordination with other metrics to ensure you have the most informative picture possible. Net operating income, monthly cash flow, cap rate, and cash-on-cash return are all useful metrics for evaluating a rental property investment beyond ROI. 

How to Use the ROI Calculator 

ROI is a useful and versatile metric used in a variety of real estate investing situations to estimate a property’s profitability. 

To use this rental property ROI calculator, first indicate whether you’ll be analyzing a cash purchase or financed purchase using the toggle. Then, enter the inputs indicated to calculate your ROI. 

While ROI itself is a simple calculation, the more difficult part is determining what the individual input values will end up being. Let’s talk about what to include for each variable in the rental ROI calculator.  

Inputs 

Here are the inputs you’ll need for this calculator: 

1. Monthly rental income 
2. Property purchase price 
3. Initial remodeling or other out-of-pocket expenses 
4. Annual insurance costs 
5. Annual property taxes 
6. Other operating expenses 

For financed transactions, you’ll also need: 

1. Down payment amount 
2. Closing costs 
3. Monthly mortgage payment 

Monthly rental income is the total income generated by a property each month, typically including rent, nonrefundable deposits, pet rent, parking fees, laundry fees, tenant utility payments, and any other payments received for the use or occupation of a property. 

The property purchase price is the price you paid for the property (if you paid in cash). 

Initial remodeling or out-of-pocket expenses refer to initial renovations completed before the property was placed into service. These are common if you purchased a fixer-upper and need to pay up front for rehabs like new flooring, upgraded plumbing, waterproofing, etc. They are often required to keep the property compliant with building and safety codes. 

Annual insurance costs and property taxes refer to your annual homeowner’s insurance premium and property tax bill.  

Any other operating expenses should be included as well. This can be a wide-ranging category, including everything from property management fees, advertising, cleaning, maintenance, insurance, property taxes, supplies, travel, legal, and HOA fees. The more granular you get with these expenses, the more precise your ROI will be. 

If you have a mortgage, you’ll also need to enter your loan down payment amount, closing costs, and monthly payment.  

Outputs 

Once you’ve entered the above values, the rental ROI calculator will output the following, including your final ROI: 

• Annual rental income 
• Cost of initial investment 
• Annual operating expenses 
• Annual return 
• Return on Investment (ROI) 

Annual rental income takes your monthly expenses and multiplies by 12 to find their annual sum. 

The cost of initial investment is the sum of your purchase price (for cash purchases) or down payment and closing costs (for financed purchases) plus any upfront remodeling expenses. 

Annual operating expenses is the sum of all your operating expenses for the year. 

Annual return is essentially your take-home profit, your rental income minus debt service and operating expenses. 

How to Interpret Your ROI 

According to Investopedia, there is no universal benchmark for what makes a good ROI. The number you should aim for depends on factors like your personal risk tolerance, the length of your investment, and industry norms. 

It is important to note that there are a few shortcomings inherent to the ROI calculation. For instance, the ROI for rental property calculator does not consider growth due to appreciation of the property over time. Appreciation has a real effect on the current market value of your investment, but it isn’t considered in this ROI calculation. 

Additionally, this calculator will largely only be accurate for conventional mortgages. For instance, if your mortgage interest rate fluctuates over time or if you have an alternative loan structure (like a balloon mortgage), your true ROI will be a bit more complex to calculate. 

It is also worth noting that many variables involved in calculating ROI change over time, meaning the result you calculate today might not be the same as the result you get next year, a year into owning the property. You may raise your tenants’ rents, see an increase in expenses, or experience rising homeowner’s insurance rates. Unexpected maintenance or legal costs are also possible. Like any metric, ROI is not a perfect predictor of a property’s success. Be prepared to adjust and always be vigilant about the value of your investments. 

Conclusion 

While there are other ways to measure the return on your investment, such as cap rate or cash-on-cash return, using a simple real estate ROI calculator is a tried-and-true method that investors rely on to determine the potential or actual success of their investments. Take advantage of this free resource to start making more informed and realistic decisions about your rental properties.