If done right, real estate investing is the way to make money and build long term financial success to secure retirement and earn a steady stream of passive income.
Making money and accumulating rental property return on investment is a feasible business plan because investors don’t need lots of money to get started and buy real estate. If you have a good credit score, you can take out a mortgage loan to buy your first rental property and kickstart your real estate business. Successful real estate investors do their homework in estimating their rental property return on investment as well as deciphering the best cities for real estate investing with good appreciation down the line. The key is to capitalize on rental properties with long term appreciation that will give investors high return years down the line.
Related: How to Make Money in Real Estate in Your Twenties
Investing For Cash Flow vs. Investing For Appreciation
Investing for cash flow vs. investing for appreciation is up to the real estate investor’s business plan and objectives. Both strategies work and reap you money and good rental property return on investment; the only difference is one focuses on short term returns while the other focuses on long term financial rewards.
Rental Property Return on Investment: Investing for Appreciation
It is important to mention, however, that investing for appreciation is a riskier venture but one which reaps higher rental property return on investment than investing for cash flow. This is pretty easy to grasp because you are waiting a longer time to get your money back and it is never guaranteed. Savvy real estate investors who choose to invest in cities with high growth incur the risk of earning negative cash flow because their returns come back years down the line. Long story short, if real estate investors solely focus on real estate appreciation, they will most likely pay their monthly expenses out of their own pockets and not the tenants’.
Rental Property Return on Investment: Investing for Cash Flow
On the other hand, if real estate investors choose to invest for cash flow, they look for rental properties in cities with higher rental income or better yet, a higher net profit margin. Cash flow is the profit landlords collect from leasing their rental property to tenants. To calculate your cash flow returns, you take gross income (rent) and subtract your total expenses (i.e. mortgage payments, taxes, insurance, repairs, etc.). In a nutshell, your net income is your rental property return on investment.
Another key piece to buying a profitable rental property is the investment property analysis conducted beforehand. It is crucial you estimate your projected net cash flow returns/net profits by weighing your cost/profit analysis. To help you do this, check out Mashvisor’s rental property calculator to give you accurate estimates on your rental property’s overall ROI and net returns. Mashvisor’s rental property calculator is customizable, allowing investors and real estate agents to punch in their own numbers to get the correct returns.
Related: Mashvisor’s Rental Property Calculator: A Guide for Beginner Real Estate Investors
What is a Good Rental Property Return on Investment?
Although there is no quota to how much you can be earning and profiting from real estate investing, do make sure you aim for at least 10% return on investment property (ROI) for the US real estate market. For beginner real estate investors, 8-10% is also a good benchmark to keep in mind.
7 Tactics to Earn Good Rental Property Return on Investment
- Target prime locations in good neighborhoods nearby schools, parks, and transportation facilities
- Buy homes selling for less than $150,000, less than 20 years old
- Hire a professional home inspector
- Take into account real estate comparables (comps)
- Your rental income must cover loan payments, taxes, insurance, fees, and (minimum of) 15% cushion for repair and vacancies
- Your operating income should be at least 1.25 times your principal and interest.
- The worst return on investment is a bad tenant. Choose tenants wisely and do not neglect to run credit and criminal background checks.
Best Formulas for Calculating Rental Property Return on Investment
One of the simplest and basic ROI formulas to keep in mind as a real estate investor is taking into account your investment property gross rental income and gross expenses.
ROI = (Annual Rental Income – Costs and Expenses)/Cost of Property
NB: This ROI formula does not take into account real estate financing: whether the property is fully paid in cash or financed via a mortgage loan.
The cap rate takes into account the net operating income (NOI) and disregards how the investment property is financed.
The Cap Rate Formula:
Cap Rate (%) = (Net Operating Income/Current Market Value) x 100
Net Operating Income (NOI) = Annual Rental Income – Operating Expenses
Current Market Value (MV) = Price of Property
For real estate comps, Mashvisor shows the cap rates for numerous rental properties (traditional and Airbnb) across the country in an instant. Cap rates are relative and should be compared with other cap rates in order to find the best real estate investment for growing your returns.
- Cash on Cash Return (CoC Return)
The CoC Return measures the cash inflow and outflow of a rental property. Capitalizing on a prime location and a good neighborhood is your best bet to earn positive cash flow returns and achieve high rental income in the long term.
Cash on Cash Return on Investment = Net Operating Income/Total Cash Investment
Related: Making the Best Real Estate Investments Based on the Cap Rate
Conclusion
Measuring your ROI is absolutely necessary to guarantee a profitable rental property return on investment. Without thorough analysis of your real estate investments and portfolio, real estate investors won’t be able to achieve financial targets and maximize their returns and earn big bucks down the line. Real estate has many financial perks if done right.
To start looking for and analyzing the best investment properties in your city and neighborhood of choice, click here.