How to calculate ROI on rental properties

Summary 

What is the ROI for rental properties? 

Investing in rental properties can be a good way to set up a passive income stream. However, not every property that you purchase to rent out might be worth your while. Before investing, it can be helpful to calculate the ROI for rental properties. 

Calculating your expected ROI  is an indicator of how much money you could make or lose on your investment. The figure represents the potential amount of money that the property could produce as well as the amount of money that you would need to put into maintaining it.  

In addition to knowing how to calculate ROI on the rental property before investing, you should perform regular ROI calculations on the rental properties you own as a method of estimating your profit margin.  

Remember, your bottom line can be affected if inflation increases maintenance costs and other expenses on the property. 

How do you calculate ROI on a rental property? 

The easiest way to calculate ROI on a rental property is to subtract the annual operating costs from the rental income and then divide the result by the property’s mortgage value.  

However, you can use a few other calculations to get a good idea of the returns you can expect when you invest in specific properties. 

A step-by-step guide to calculating ROI 

Take a closer look at different calculations you can use to work out the annual ROI on rental property.  

These include calculations for cash flow ROI, cash-on-cash return, cap rate, and net operating income: 

Cash flow properties are so named because they generate a steady stream of income month by month after you have paid the operating expenses.  

Operating expenses to consider include advertising or marketing when looking for tenants, maintenance, repairs, insurance, property taxes, and property management services if you hire someone to look after the property on your behalf. 

The cash flow ROI calculation offers a good idea of how much money you can expect to receive monthly from a rental property.  

Based on the money that comes in and the money that goes out, the cash flow ROI calculation is relatively simple: 

Gross rent – expenses = cash flow 

The cash-on-cash return calculation is ideal if you want to calculate ROI on a rental property to measure its annual cash flow based on the amount of money you invest.  

This calculation is usually used to gain an understanding of how well you can expect a rental property to perform over a specific year based on your cash investment in it.  

The calculation to use is: 

Annual cash flow / total cash invested x 100 = cash-on-cash return 

Properly termed the capitalization rate, a rental property’s cap rate is the estimated rate of return on the property.  

The lower the cap rate, the lower the potential risk, and the higher the cap rate, the higher the potential risk.  

To work out the cap rate when calculating ROI on a rental property, you need to divide the property’s net operating income by its purchase price as follows: 

Net operating income/purchase price x 100 = cap rate 

The difference between the rental income generated by a property and what you pay in terms of vacancy losses and operating expenses is known as the net operating income or NOI.  

The NOI measures profitability based only on these factors — it does not take mortgage expenses into account. It’s important to remember this if you have taken out a mortgage to pay for the property.  

You can use NOI to calculate ROI on a rental property when you want to compare two or more properties, as mortgage details are not required for these calculations.  

Use the following calculation to work out the NOI for a rental property: 

Rental income – operating expenses – vacancy losses = NOI 

What is the 2% rule when calculating ROI on a rental property? 

Another simple way to calculate the ROI on a rental property is to use what’s known in real estate as the 2% rule.  

According to this rule, a rental property should generate positive cash flow if the monthly rent for it is at least 2% of the purchase price. Use the following calculation for the 2% rule: 

Monthly rent / purchase price x 100 = X% 

What are the tools and resources for ROI calculation? 

As simple as the above calculations for ROI on rental property are, preparing to do them requires attention to detail and gathering various information such as maintenance and other costs.  

Using tools and resources such as websites and apps can help save time and provide enhanced accuracy.  

A few tools you can use include: 

What is a good ROI on a rental property? 

There is no single figure that represents a good ROI on a rental property due to the many different factors that can affect the returns generated by a property.  

These factors include the purchase price, mortgage costs, occupancy and vacancy rates, operating expenses, and rental income. 

When considering a rental property’s ROI, it can help to consider your own goals, such as whether you have a cash flow target or baseline ROI that you want to reach every month or year.  

This can help you evaluate potential investments and choose those that best align with your goals and risk tolerance. 

Get expert financial advice 

Knowing how to determine ROI on rental property can be a good guide when making investment decisions, especially if you are looking to create a stream of passive income.  

However, there are several different factors to consider, which can make it tricky to perform accurate calculations.  

A financial advisor can help you navigate rental property ROI calculations and investment options.  

Match with a financial advisor through Unbiased for expert financial advice tailored to your exact needs.