Investors who buy residential rental property do so to generate passive income-but how can you know if you’re making enough money for your investment properties?
When thinking of a real estate purchase as part of an investment portfolio, it is important to calculate the return on investment to determine the property's profitability. The ROI on a property helps determine whether the purchase is a good investment that will meet your expectations for returns. New investors or those considering investing should discuss options with the best property management Atlanta offers. As you consider investing in residential rental property, here’s the formula to calculate ROI for a property.
What Exactly Is ROI?
Return on investment (ROI) measures how much profit an investor can expect from an asset as a percentage of the cost of that purchase. While it’s a common metric for other types of investments (like stocks and bonds), real estate investments must apply this metric to track progress toward income goals.
Since various factors can influence the formula for ROI (and your returns, it’s critical to understand the formula.
What’s the Formula?
To calculate the profit, or net gain, on an investment, investors can subtract the original cost of the investment from the total return of the asset, which includes increased value or return since the purchase.
Then, ROI is calculated by dividing the net gain of the investment by the asset's original cost. Since ROI is a profitability ratio, the profit is represented as a percentage. While the basic concept of calculating ROI is pretty simple, factors related to residential real estate can affect the calculation.
Certain expenses, such asrenovations and property maintenance, can affect ROI. In addition, the amount of money borrowed by the investor and the terms of the loan to purchase the property can also impact ROI. Fortunately, doing these calculations can help you answer questions like 'how much can I rent my house for,' to ensure that the income generated by the property offsets costs while leaving you with profit!
An ROI Example for Rental Properties
Let's examine what ROI looks like for a residential rental property in Atlanta, GA. In this example, we'll look at a property purchased using cash (and without any financing).
An investor pays $150,000 for a rental property and spends another $15,000 in closing and renovation costs to get the unit ready to rent. This brings the initial investment cost to $165,000. Once the property is ready, our real estate investor collects $1,500 a month in rent, which produces $18,000 in annual income on the property.
Then, ongoing costs come to $4,800 per year, including insurance premiums, utilities, property taxes, and more. Factoring in these costs means the property delivers $13,200 in profit every year.
To calculate the property's ROI, divide the annual return of $13,200 by the original cost of the investment $165,000). This calculation shows the property's ROI is .08 (or 8% when multiplying by 100 to review as a profitability ratio). Consulting with a trusted advisor who specializes in property management Atlanta landlords trust can help you understand the numbers and how they factor into your long-term goals.
ROI for Financed Real Estate Investments Is Trickier
If you need to take out a loan to purchase an investment property, then determining your ROI requires a little bit more legwork. Investors mustfactor in mortgage costs, downpayment, and interest when running the formula. We’ll talk more about that in an upcoming blog!
What Can Rental Property Owners Do to Improve ROI?
What happens if your ROI is too low? Most Atlanta property managers can tell you that an ROI between 8-12% is good for an investment property. However, if your return sinks below 8%, it’s time to evaluate the property, costs, and rental rate to determine where you can make improvements.
A good property management company can help you analyze the rental rate and recommend adjustments if it’s too low (or too high) compared to competitive market rates. In addition, the right property manager can recommend property upgrades that can justify a rate increase and help you attract quality, long-term renters to boost cash flow.
The best property management companies also review your budget and expenses to find areas where costs reductions can improve the bottom line (without sacrificing quality or services that renters appreciate).
Analyze ROI With One of the Best Atlanta Property Management Companies
Real estate is a significant investment, so it's essential to understand all the variables affecting your potential returns. If you're thinking about reaching out to Atlanta property management companies for help, then you've come to the right place. Contact the property management experts at Revolution Rental Management who can offer guidance and expertise when buying, managing, and maintaining all of your rental properties! Our full-service property management team is here to help you maximize long-term returns.