How A Landlord Can Determine the “REAL” ROI of Rental Property?
Admin - Nov 5, 2016
As the name suggests, return on investment or ROI is the return or profitability you make on investing money. In real estate flips, it is determined by the difference between the buying price and the selling price of a property. But when it comes to find the ROI of rental properties, it becomes bit different from the common ROI formula.
A landlord has to consider several costs regarding property maintenance, taxes, insurances, and expenses during vacancy to find the accurate ROI.
Annual Property Taxes –
You can’t keep annual property taxes out of calculation as Texas has some of the highest property taxes in the nation. The Lone Star State charges 1.94% tax rate of the value of the property, the 4th highest rate of any state. So, it is one of the factors to be added into your ROI calculation.
Property Improvement and Rehabs:
Whether it’s a foreclosed home or flipping property, a home requires maintenance at least for being attractive enough for tenants. Even minor renovations and touch ups are as expensive as your 2-3 months’ rent. Therefore, the property improvement cost must be in ROI calculations.
To ensure a maximum ROI, you need to buy insurance policy available at the reasonable rates. Shop around to get the quote from property insurance companies. Working with an insurance agent specializing in real estate deals is great as they understand your business. Be sure to check the rating of the insurance company as you want to know they have the funds to pay out a claim should you ever have one. It’s up to you but I recommend choosing replacement costs so that worst case scenario I could rebuild the rental property.
Apart from that, avoid buying rental properties in areas prone to natural disasters like flood and earthquake as insurances for these conditions are expensive.
HOA or Home Owner Association is one of the hidden costs which can be charged off monthly, quarterly and annually. An HOA fee can really affect the ROI for a landlord as the fee may be as large as $1,000 and more. So, you must know HOA charges and relating conditions before investing in property in that area.
If you use a property manager to take care of your rental property, it would cost you around 8-10% of your monthly rent. Plus, some property manages charge a leasing fee. Keep that also in mind while doing calculation for ROI.
Any vacancy will affect your returns and its normal to have some vacancy in between tenants and doing repairs. Vacancy means no income and puts a hardship on landlords to cover costs like mortgages, property taxes, and utility bills. Plug in at least 5% of annual rent revenue to account for vacancy expenses.
Last but not the least factor to be added into your ROI calculations is loan payments of rehab or landlord loans. The monthly installments are set on the basis of your down payment, credit score and income. So, take out your calculator to find the ROI.
First of all, we will plug into the above mentioned costs in following way to find Net Revenue:
Annual Gross Rent – Annual HOA – Vacancy Factor – Annual Property Management – Insurance – Annual Maintenance – Annual Property Taxes – Annual Loan Payments = Net Revenue
In this way, you will get your Net Revenue. Now, calculate your Net Revenue in the following way to know your real ROI.
Net Revenue / Cash Invested = Return on Investment
The figure you get after this calculation is your real “ROI” of rental property.
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