Do you want to succeed in real estate investing? You’re going to have to learn what is a good rate of return on investments first.
Analyzing a rental property’s performance is crucial. When it comes to real estate investments, a good rate of return on investments is key. ROI is the single most important metric to consider when it comes to purchasing rental properties, so you’re going to want to understand it. This metric measures the profitability and performance of an investment property but isn’t as simple as it may seem. Here’s the breakdown of this blog:
#1. What Is Return on Investment?
#2. How to Calculate Return on Investment.
#3. Other Metrics to Measure the Rate of Return on Investments
#4. What Is a Good Rate of Return on Investments?
#1. What is Return on Investment?
Most successful real estate investors already know the significance of a good rate of return on investments. The simplest measure of rate of return on investments is the return on investment (ROI). However, you’d be shocked to hear the number of real estate investors who don’t even know what ROI is. Knowledge can make or break your real estate investing career, so pay attention.
Return on investment is the most important number in all of real estate investing. Like we mentioned above, it’s basically a measure of a real estate investment’s profitability. An investment property that you’re renting out is considered an income property. And the rental income generated by this investment property is a key part of the cash flow. Your return on investment (ROI) is equal to the property’s cash flow, which is its income minus expenses, as well as the equity that builds up.
If a rental property has positive cash flow, that means you’re profiting. You’re making money because your rental income is greater than the expenses. If a rental property has negative cash flow, however, that means you’re losing money. When the income generated by the real estate property isn’t enough to cover its expenses, it’s a bad sign. A very obvious one at that, making ROI a great indicator of the rate of return on investments.
Related: Why Positive Cash Flow Is a Must With Income Properties
#2. How to Calculate Return on Investment
ROI= Cash Flow/ Total Investment
For example, let’s say you bought a rental property for $100,000 (including closing costs and remodeling), this would be the amount of total investment. You collect $1,000 in rent every month, making the annual rental income $12,000. Assume you had expenses throughout the year of $2,200 (water/electricity bills, maintenance, etc.). Subtracting the $2,200 from the $12,000 gives us an annual cash flow of $9,800. Final ROI would be $9,800/$100,000 = 0.098 or 9.8%.
That was a pretty basic and straightforward calculation, but we all know in real estate investing, calculations could get a bit tricky. There are many other determining factors affecting the calculation of the ROI. A couple other things to consider in the return on investment calculation are:
- Income: There is a good chance you won’t be collecting your full rental income every month. This might be due to vacancies or late rent payments.
- Financing: The calculation for ROI differs when you take out a loan on your investment property. Mortgage payments become the number one expense.
- Extra Expenses: This could be anything specific to your rental property. For example, if you were hiring professional property management, that would be considered an expense.
- Taxes: The implication of taxes differs based on each real estate investor’s personal tax situation. The cash flow generated by your property may be taxable.
If all of this information has left you overwhelmed, we’re here to tell you it’s okay. You don’t need to deal with the complications of calculating all these numbers on your own. That’s what a rental property calculator exists for. Use the best one out there, check out Mashvisor’s investment property calculator! To learn more about how it can help all real estate investors, click here.
#3. Other Metrics to Measure the Rate of Return on Investments
The ROI isn’t the only way to measure what is a good rate of return on investments. Here are a couple other metrics you might’ve heard about:
- Cap Rate: Short for the capitalization rate, cap rate is another metric used for measuring the rate of return on an investment. The cap rate formula is the NOI/Purchase Price. A good cap rate would be around 6-8%.
- Cash on Cash Return: The CoC return measures the relationship between the total cash invested and the annual cash flow (NOI). This is typically used in cases when a mortgage is involved. To learn more about what a good cash on cash return is, click here.
- Internal Rate of Return: Real estate investments are a great choice because they’re known to appreciate instead of depreciate as time passes. This is great because it means you own an asset that is increasing in value with time. So you’re also building equity, which adds to your return. The combination of your cash flow and the equity you build is known as your total return, or internal rate of return (IRR).
Note: All the above-mentioned metrics and more can be found with the use of Mashvisor’s investment property calculator. To learn more about our product, click here.
Related: Cap Rate vs. Cash on Cash Return
#4. What Is a Good Rate of Return on Investments?
Whether you’re using ROI, cap rate, CoC return, IRR, or any other metric, it’s important to know what number makes for a good rate of return on investments. In real estate investing, it’s always difficult to have a direct answer which applies for every investment. A good rate of return on investments could differ from one investment to the other. Things like location, the local housing market, and the type of property, could all affect our perception of a ‘good’ rate of return on investments. So, what is a good rate of return on investments? We’ve already talked about a good cap rate and a good CoC return, but in regards to ROI, we can say 12-15% or above is considered ‘good’.
Again, it all depends on your specific situation. If you’re making a fairly risky investment, you should be expecting high returns, so a good rate of return on investments would be a high percentage, maybe even 20%. To make your real estate investing decisions easier, sign up for Mashvisor! We use predictive analytics to find and analyze real estate investment property. To learn more about how we will help you make faster and smarter real estate investment decisions, click here.