How to Calculate ROI on Rental Property: The 2022 Guide

How to calculate ROI on rental property is one of the first things on real estate investors’ minds concerning investment properties.

Table of Contents

1. The 2022 Guide on How to Calculate ROI on Rental Property
2. Mashvisor’s Investment Property Calculator: A Real Estate Investor’s Best Friend
3. Final Words

Below, we will discuss how to calculate ROI on rental property, why doing so is important, and what factors one should consider when computing property profitability.   

The 2022 Guide on How to Calculate ROI on Rental Property

Making money in real estate is the primary reason why business-minded people choose to invest in rental properties. Their goal is to not just break even but to actually make a decent profit. To make sure that a certain property helps them meet their goals, investors do their digging to find out if it can give them a positive cash flow and generate good investment returns. 

What is ROI in Real Estate?

Before we go any further, let’s talk about what ROI is. The letters R-O-I simply stand for return on investment.

In business ventures, your investment is the resource you put into either making an acquisition or improving an organization or company. In most cases, the resources include, but are not limited to, time and money. The profit resulting from a particular business or financial venture is called the return on investment. 

Return on investment is the monetary value calculation of an investment against its cost. In simpler terms, it’s how much money your investment will make for every dollar you put in. One can compute the ROI using the following formula: 

ROI = (Profit – Cost)/Cost

For instance, you put an initial investment of $1,000 and earned $10,000 from it. Using the formula above ($10,000 – $1,000/1,000), your ROI is 900%. Or, let’s say you invested the same amount of money and realized a net profit of $600 after some time. With the same formula, you will end up with a result of 60% as your ROI. 

Why It Matters to Real Estate Investors

The concern now on people’s minds aside from how to calculate ROI on rental property is why it actually matters to real estate investors.

Just like any other type of investment, investing in real estate is something that people get into in the hope of creating an additional income stream. The ultimate goal of any investor is to make money from their investment. Thus, calculating the yield on rental property investments is crucial as it gives them an idea of how much they can make from the money they put into it. It makes one an informed investor.

Knowing the potential ROI on a property allows one to estimate costs and expenses associated with it, as well as the potential rental income based on rental comps. In such a way, whatever rental property types investors are considering, it makes it easier for them to conduct a proper investment property analysis. It is especially important in the 2022 housing market, given the red-hot real estate scene in 2021. 

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Related: How to Achieve a High ROI on Rental Property Every Time

How to Calculate ROI in Real Estate

Computing for an investment return is easy as long as you know the ROI formula real estate investors use. We’ve already given the basic ROI formula earlier. Here are some formulas on how to calculate ROI on rental property:

Cash Transaction ROI

Computation for ROI will depend on the type of transaction made. Knowing how to calculate ROI on rental property is made more accurate if you take into consideration the kind of purchase made if it’s paid for in cash or by means of financing. 

For cash transactions, let’s take a look at a sample scenario to give you an idea of how to calculate ROI on rental property: 

Let’s say you paid $100,000 for a real estate property in cash. On top of that, you also shelled out $1,000 for closing costs and another $9,000 for home improvements. They bring your investment total to $110,000 for the said rental property. 

You decide to rent out the property to a tenant for one full year at a rate of $1,000 per month. After a year, you collected a total of $12,000 from your rental property. However, during the entire year, you needed to cover some reasonable expenses, such as property taxes, insurance, and other costs. The expenses ate up around $2,400 for the year or $200 per month. It means that your annual return for the investment property is $9,600 ($12,000 – $2,400).

To know your ROI for your investment, you should divide your annual return by the total amount of cash invested in the property. By tweaking the formula given earlier, here is what we get: 

• ROI = Profit – Expenses/Cash Investment Cost
• $12,000 – $2,400/$110,000 = 0.087

The return on your $110,000-investment is 8.7%. 

Financed Transaction ROI

Now, since not every investor holds enough cash to expand their real estate portfolio, a few ones need to take loans and other financing options to get into the real estate market game. Computing for ROI on financed investment properties is slightly different from properties purchased with cash. They can be a bit more involved. Let’s take a quick look at another example. 

Let’s assume that you decided to purchase the same property for $100,000. However, you decided to take out a mortgage instead of paying in cash. You will need to consider the down payment for the mortgage on top of the closing costs and costs for repairs. 

Let’s say that the mortgage you took out required 20% of the purchase price as a down payment. If the property costs $100,000, 20% of it is $20,000. And since you took out a mortgage, expect closing costs to be higher, which is quite typical for almost all mortgages. Instead of paying just $1,000 for closing costs, you will need to shell out $2,500 upfront. And then you spend $9,000 to repair and remodel the property to make it suitable for your needs. 

To know what your out-of-pocket expenses are, you need to get the sum of your down payment, closing costs, and home repair costs. In this case, your total out-of-pocket expenses were $31,500 ($20,000 + $2,500 + $9,000).

Since you went with a mortgage, you also need to take into account the ongoing costs associated with it. 

Assuming you took a standard 30-year fixed-rate mortgage with 4% interest, your monthly payments (principal + interest) for the $80,000 you borrowed would be $381.93. You will still need to consider your monthly expenses, so we’ll add another $200 per month (or $2,400 a year), bringing your monthly expenses up to $581.93.

You decide to get the property rented out for a year at $1,000 a month. It means you end the contract with $12,000 to your name. The next thing you need to do is deduct your expenses from your income to determine your cash flow. 

• Monthly Cash Flow = $1,000 (Rental Income) – $581.93 (Monthly Expenses)

Based on the given information and the formula above, your monthly cash flow is $418.07 or $5,016.84 for one whole year. 

To know how to calculate ROI on rental property that is financed, divide your annual return by the total amount of cash (out-of-pocket expenses) it took to purchase the property. 

• ROI = Annual Cash Flow/Out-of-Pocket Expenses
• $5,016.84/$31,500 = 0.159

It brings your annual ROI, in terms of percentage, to 15.9%.

Cap Rate vs Cash on Cash Return

Two terms that are used interchangeably are cap rate and cash on cash return. While they may seem similar, there is a whole world of difference when it comes to determining ROI and profitability. Investors should know the difference between the two so they know which metric works best on how to calculate ROI on rental property. 

A cap rate formula is fairly simple to understand. It just takes a property’s net operating income and divides it by the property’s purchase price. While it is a good way of projecting ROI, it doesn’t take into account financing methods, which can be a problem for those who intend to take out a loan or mortgage. 

On the other hand, cash on cash return is a metric used to determine ROI that considers the financing method used to acquire the property. It takes your pre-tax net profit and divides it by the total amount of cash used to buy the property. A lot of investors use this metric to determine investment profitability since they need to go with a financing option to purchase real estate. 

Related: What Is a Good Cash on Cash Return?

Mashvisor’s Investment Property Calculator: A Real Estate Investor’s Best Friend

The smart investor will always look for the best real estate strategy that will get the best returns. It can only be done with accurate market data and the right real estate investment tools.  

What Is Mashvisor?

Mashvisor is a website intended to make real estate investment a breeze for all types of investors, whether they’re veterans or newbies. 

Investing in real estate is a matter that should be taken seriously. It is not a get-rich-quick scheme. It takes plenty of hard work and commitment to pull off. It entails countless hours of research and due diligence. Market research, property analysis, number verification, and all sorts of information and data gathering methods take too much time and lots of money to accomplish, especially if an investor is considering out-of-town properties.

Doing it all manually in today’s modern world is such a waste of time and money. For such reason, websites like Mashvisor were created to make research and real estate market analysis easier and faster. The websites allow investors to look for the best possible deals in a fraction of the time. 

One of Mashvisor’s strengths, on top of its massively accurate real estate database that covers almost all markets across the US, is its property analysis feature. With its wide coverage and up-to-date data, real estate analysis has never been easier. 

And while Mashvisor allows investors to search for properties in different states, one of its tools – the investment property calculator – is quite useful for computing ROI on rental properties. 

How Does the Investment Property Calculator Work?

So let’s say you’re an investor looking for a rental property and you use Mashvisor’s Search Page to find several properties that are publicly listed on the MLS. You use its filters and zoom in on a particular market and neighborhood. In a matter of minutes, the website then gives you a list of potential investment properties that match your criteria. 

Once you’ve identified which properties interest you, you now proceed to the Property Analytics Page, or the investment property calculator, to crunch the numbers and make sure the math checks out. 

Unlike typical calculators, Mashvisor’s online real estate investment calculator helps investors identify which among their prospects is the most profitable choice. In line with our topic on how to calculate ROI on rental property, Mashvisor’s investment property calculator comes with a number of features that allow investors to see if a property is good enough to generate a handsome return and cash flow. 

Financing Calculator

For those who plan to purchase an investment property through financing, the financing calculator is very helpful as it is highly interactive. It means that depending on the values entered, the calculator makes the necessary adjustments and recomputes the projected ROI on rental property. It allows users to fiddle around with the numbers to see which mortgage type, down payment amount, and loan amount will yield the most profitable results.  

Related: What Is a Good Return on Investment for a Rental Property?

Rental Strategy

Another very helpful feature of the investment calculator is that it also gives investors an idea of which rental strategy works best for a particular property. It will provide you with a side-by-side comparison of what’s in store for investors if they go with the traditional rental route or a vacation home rental. After comparing the rental strategies, investors can decide which steps to take moving forward. 

Expenses

The investment calculator also takes into account overhead expenses involved in the property purchase. The expenses include both one-time startup costs and recurring expenses. Generally, the expenses drawn by the system are based on rental comps and local rates for both traditional and short-term rentals. 

For a more accurate calculation, it is recommended that investors do their own research on the local rates. Once the user’s entered all the necessary information, the calculator will do the math for you. When it’s done, it will not only show you an estimate of the possible expenses but also give you an estimate of how long it will take to recover your investment. Basically, it will give you a projected monthly and annual performance. 

Final Words

When discussing the topic of how to calculate ROI on the rental property, it is very important for investors to always make sure all the bases are covered by performing thorough research and extensive due diligence. Doing so increases the accuracy of your calculations. Of course, it also helps when you use the right tools to help you perform your rental market analysis. 

To get access to our real estate investment tools, click here to sign up for a 7-day free trial of Mashvisor today, followed by 15% off for life.