How much can I rent my house for? How do I calculate the return for my rental property investment? If you’re asking these questions, you’ve come to the right place for answers!
However, when buying real estate, property owners have two options: paying for it with cash or financing part of the transaction. While both methods have pros and cons, real estate investors should understand the differences between calculating ROI on properties purchased with cash versus those purchased through financing.
Today our Atlanta property management team will show you how to calculate your return on investment (ROI) when buying a property using only cash.
What is Return on Investment (ROI)?
When calculating the ROI on a cash transaction, how do you know if you’re making any money? One excellent way to evaluate profitability is to use a formula for ROI.
Return on investment weighs all costs against the profits for a rental property. Therefore, for accurate calculations, it’s essential to consider all of the costs involved, including fees associated with the sale and closing process, as well as tax requirements, ongoing maintenance, and more.
ROI is an excellent formula for knowing which investments offer a good return on investment and which might need some adjustments to generate a better return.
Using this universal formula for properties currently in your portfolio or for properties you plan to buy will give you a good idea of what to expect from rental property revenue. However, depending on how you purchase a rental unit, property owners must understand what’s involved in the formula for a financed property vs. a rental home purchased with only cash.
How to Calculate ROI When Paying Cash
When acquiring a new property without using a mortgage, the formula is simpler for calculating returns. The method to calculate the ROI when paying with cash is fairly straightforward.
- You paid $200,000 in cash for a new property you plan to use as a rental unit.
- Your closing costs were $7,500. You also spend about $13,500 on the property for renovations and improvements to get it ready to rent to tenants. This brings the total initial investment for the property to $221,000.
- Every month, your property collects $2,000 in rent.
Then, after twelve months with a tenant:
- Your rental property generated $24,000 in rental income from those 12 months.
- Tenant screening costs, insurance, property taxes, and maintenance totaled $4,800 in expenses for the year (or $400 monthly).
- To calculate your net income after the first year, subtract $4,800 in expenses from the $24,000 in rental revenue to get an annual net revenue of $19,200.
Finally, to determine the property's return on investment, use the following formula:
- Divide the annual return ($19,200) from the total initial investment cost ($221,000). This comes to .087.
- To see this number as an ROI or profitability ratio, multiply the number by 100. Your return on investment was 8.7%.
When using cash to invest in real estate, make sure you consider all the factors involved in the calculation. It is easy to get carried away with numbers and forget some important aspects of the equation.
However, one critical thing you don’t need to plug into the formula when buying a cash-only property is the monthly mortgage payment!
What Investors Need to Consider For Financed Transactions
When calculating return on investment with financing, investors must also factor in mortgage payments, mortgage insurance, and other fees.
These costs can add up quickly and can significantly reduce the amount of money that an investor will be able to return on their investment. When running your ROI formula, make sure to plug in these costs to get an accurate number to analyze returns.
How Can You Improve ROI?
Whether you finance a property or pay cash in full, a property manager can help you apply strategies to improve returns! For example, sometimes adjusting the rental rate based on market conditions or making property updates and improving tenant retention are critical best practices that can improve ROI for rental properties.
Boost Your Return On Investment With Atlanta, Georgia Property Management
When investing in real estate, maintaining consistent cash flow and improving returns are critical for long-term success! However, there is no one-size-fits-all solution when it comes to the strategies that will work best for properties in your real estate portfolio. That’s why working with property management professionals can be the best way to evaluate returns for potential properties (before buying an income-losing investment) and improve profitability for rental properties you own now.
Revolution Rental Management helps property owners run the number and manage rentals to meet their ROI and long-term goals. Reach out today to learn more about how our property management services can help.