If you’re a real estate investor and you’re investing in rental properties, then perhaps you’re wondering how to determine your rental income.
One of the key aspects of real estate investing is your ability to analyze an investment to determine the amount of profit that you can make from it.
The case is no different when you’re investing in rental properties, both short-term and long-term rentals. In order to project the amount of profits that you can make from investing in a rental property, you should be able to determine your rental income.
This article aims to help you understand what the rental income is, and how you can determine your rental income to project the return on investment that you will generate from investing in a rental property.
What Is Rental Income?
The rental income is the amount of profit that you will make from a rental property after factoring in all expenses, management costs, mortgage payments, occupancy rate, and other aspects of your investment.
In its simplest form, the rental income of your rental property is the amount of rent that the tenant pays you at the end of the month (for traditional rentals) or once their stay is over (for Airbnb rentals).
However, owning and running a rental property will also result in certain expenses that should be taken into consideration.
To make it easier to understand, let’s look at some of the other metrics that, in some way or another, represent the amount of rental income that you will make:
- Comparable Rental Income
- Net Operating Income
- Cash Flow
Comparable Rental Income
When you’re trying to compare a number of properties based on their rental income, it makes sense to factor in for each property’s occupancy rate in order to determine your rental income from investing in each property.
The comparable rental income, one of the main metrics used by real estate analytics platforms such as Mashvisor, is the rental income of a property after accounting for its occupancy or vacancy rate.
The term “comparable rental income” is used here because you can’t compare the rental income of different rental properties while disregarding their occupancy rate. So, when you’re doing a comparison, you should always use the comparable rental income metric.
For example, if you have two rental properties to compare and one property has a rental income of $1,200/month, while the other one has $1,000/month, a beginner real estate investor might immediately think that the first property has a higher rental income than the second one.
However, if the first property had an occupancy rate of 60%, and the second property had an occupancy rate of 80%, their annual comparable rental income would be $8,640 for the first property, and $9,600 for the second property.
Obviously, when looking at the comparable rental income of these properties, you can see that the second property is projected to generate $960 more than the first one each year. So, you can see how important it is to use the comparable rental income in this case.
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Net Operating Income
The net operating income is another metric that you can use to determine your rental income.
The NOI is one of the most commonly used metrics in real estate investing, and it is the amount of rental income that is left over after paying all operating expenses.
Now, let’s go back to the previous example and see how the NOI looks for each property.
This time, let’s factor in each property’s expenses. We will assume that the first property’s annual expenses amount to $4,300, while the second property’s annual expenses amount to $5,500.
This means that the first property’s NOI is $4,340 ($8,640 – $4,300), while the second property’s NOI is $4,100 ($9,600 – $5,500).
This means that the first property is projected to generate slightly higher NOI than the first property.
The last metric I want to talk about that is used to determine your rental income is the property’s cash flow.
The cash flow metric is used to calculate the property’s actual rental income after factoring in the occupancy rate and expenses as well as the financing method – mortgage payments.
When looking at the examples above, you can tell that the first property might be a better investment than the second property because it generates slightly higher profits.
However, one of the key factors that will affect your rental income, and one that will consume a large portion of your profits, is the mortgage payments.
Before analyzing the property to determine your rental income, it is necessary to decide on the financing method that you want to use for purchasing the property.
If you opt for using a mortgage loan, you should always make sure to calculate the monthly and annual mortgage payments that will incur, and you should factor in that amount in your rental income calculations in order to get the rental property’s cash flow.
The amount of money that you use annually to pay down your mortgage must be deducted from your property’s NOI. This will give you a clear and accurate calculation for the actual amount of profit that your rental property will generate each year.
Note that the cash flow can either be positive or negative. A negative cash flow will mean that your property is costing you more money than it is generating, while a positive cash flow means that your property is bringing in profits.
While it isn’t recommended to invest in a rental property that has a negative cash flow, some properties might start generating much higher profits once the mortgage has been fully paid. If you don’t mind losing money on your investment for several years before it starts generating profits, then this strategy might be of interest to you, but you should certainly do some research on it to see if it makes sense in your case.
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Whether you’re a beginner real estate investor or a veteran one, one of the main factors of your investment’s success is your ability to accurately and reliably determine your rental income using the different metrics mentioned above.
Of course, determining your rental income on its own is not sufficient for achieving the optimal investment. However, it will give you the first step that you will use when calculating all the other different metrics when analyzing your investment property, and it allows you to know the exact return on investment that your investment will have in the short and long run.
Make sure to check out our articles on analyzing rental properties and on choosing the right location for your property in order to generate the highest returns.