Investing in the real estate market is one of the greatest ways to make money. However, real estate investors have to be aware of negative return on investment and not expect high returns immediately after purchasing the income property.
The rate of return (ROI) is simply the amount of profit you make from the investment properties over a period of time, calculated in the form of a percentage. This percentage could be positive, indicating that your income property is making money, or it could be negative. For example, assume you invested in a $125,000 rental property that provided you with a return of $100,000. The basic way of calculating ROI requires taking the return generated by the investment, subtracting the initial investment, and then dividing by the initial investment. Thus, the ROI calculation would be:
$(100,000 – $125,000)/$125,000 = -0.2, or a negative return on investment of 20%
Related: The Ultimate Guide to Rate of Return on Investment Properties
A negative return on investment means that investment properties are actually losing money. In this scenario where the costs have exceeded the income, the real estate investor will end up with less than what he/she initially invested, which is clearly something no real estate investor wants.
Negative return on investment does not necessarily indicate a failed real estate investment. However, if the real estate investor is losing money form the investment property and doesn’t act right away, he/she will face the risk of a complete loss of the initial capital invested in the investment property. So, the main questions to ask now would be “What are the causes of negative return on investment?” and “What can a real estate investor do to avoid negative ROI?”
Causes of Negative Return on Investment
1. You Paid Way Too Much
Experienced real estate investors know that you make your money on the front end of a deal. In other words, you make a profit if you spend as little as possible when you purchase an income property. If you pay too much, you’ll be burdened by an over-sized mortgage for years and possibly make a lot less when you decide to sell your income property.
2. Turnover Rate Is Too High
Tenant turnover is a major cause of negative return on investment as it raises real estate investors’ expenses. When real estate investors face tenant turnover, they have to pay for cleaning services, paint touch-ups, marketing, advertising, etc. A rental property without a tenant loses money every day it remains vacant.
3. Long Vacancy Periods
If your turnover rates are high, it’s possible that you’ll experience long vacancy periods. This is another cause of negative return on investment as vacancies can cost real estate investors hundreds – even thousands – of dollars, depending on how much they charge and on their monthly mortgage.
4. Spending Too Little or Too Much on Maintenance
There’s a fine line between over- and under-spending, and you don’t want to fall on either side of the line.
It may seem counter intuitive, but real estate investors could actually have a negative return on investment and lose money as a result of not putting enough money into their rental property. In other words, not paying for necessary maintenance and renovations limits how much rent real estate investors can charge tenants.
On the other hand, it’s possible that the opposite is the case. You should certainly pay for necessities like regular cleanings and touch-ups, but you shouldn’t treat the investment property like a million-dollar house and go overboard with renovations.
5. Not Adjusting Rent
Many real estate investors are willing to maintain the same level of rent for years and years. However, taxes, insurance, utility costs, repair costs, etc. all go up over the years. Therefore, if real estate investors don’t adjust rent as these costs change, they might be missing out on hundreds or even thousands of dollars per year, thus causing negative ROI.
Now, let’s see what real estate investors could do to avoid negative return on investment.
7 Ways to Avoid Negative Return on Investment
1. Conduct Real Estate Market Analysis
Before you invest in an income property, conduct real estate market analysis. Based on the characteristics and performance of other real estate investment properties nearby, you will get an idea of what average rate of return to expect from your target income property.
It can take a lot of time and effort to find the best deal, but it’ll be worth it in the long run as it ensures that you don’t invest in a rental property that generates a negative return on investment. You can use Mashvisor’s investment property calculator, which gives you all the numbers that you need within only a few seconds.
2. Perform Real Estate Investment Property Analysis
After you find an income property, calculate its expected cash flow, net operating income (NOI), capitalization (cap) rate, and cash on cash (CoC) return. All these numbers will reveal crucially important information about the profitability of your income property, which helps you recognize if it causes a negative ROI.
Related: Evaluate Real Estate Investment Performance Using Rate of Return
3. Use a Real Estate Investment Property Calculator
Time is money! So, instead of wasting time on real estate market analysis and investment property analysis, you should get a rental property calculator. Mashvisor’s rental property calculator is the best one out there. Not only will it save you time and energy, it also provides you with an amount of information that you can’t possibly find on your own.
Related: Using Mashvisor’s Investment Property Calculator to Estimate Rate of Return
4. Choose Your Location Carefully
Location is a key factor for success in real estate investment. It determines how much an income property will cost, how much rent you can ask for, long-term appreciation, etc. Therefore, to avoid negative return on investment, you should do proper research on how the investment properties have been performing in your target location.
5. Choose Your Tenants Carefully
In the real estate market, tenants play a major role in the success of the investment property. After purchasing an income property and preparing to rent it out, a real estate investor needs to make sure to spend sufficient time and effort when choosing tenants. The right tenant will not destroy your income property and will pay rent on time, which will factor in not requiring major maintenance costs that will bring down your profitability. Also, if real estate investors don’t receive their income from their real estate rental property, they will automatically start losing money from the income property.
6. Avoid Professional Property Management
Sometimes, when the real estate investor has a full-time job, owns multiple real estate investment properties, or has an income property too far away, he/she ends up hiring a professional property manager. However, this comes with a price and costs money. Thus, if you think you might actually be receiving a negative return on investment from an income property, don’t get professional property management.
7. Reduce Turnover and Vacancy
Reducing turnover is all about realizing the underlying issues and addressing them quickly. Every time a tenant leaves, ask for some honest feedback on what caused him/her to leave. It could be high rent, lack of security, old utilities, or even poor communication on your part.
Obviously, the best way to eliminate vacancies is to reduce turnover. However, there are other things real estate investors can do to avoid this situation. When you find good tenants, keep them satisfied by maintaining your rental property well and be responsive to their needs. If you’re going to evict a tenant and thus know that a vacancy is coming up, don’t delay in preparing the rental property for new tenants and marketing it through several channels so it reaches the most people and reduces the chances of negative return on investment.
In the real estate market, negative return on investment is not something to take lightly. As a real estate investor, you don’t want to lose money on your income property, do you? One negative ROI can wipe out many years of positive ROI. This is why you need to know the causes of negative returns and what you can do to avoid them.
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If you’re following through this series of blogs related to the rate of return on real estate investments, you’ve covered the three types of returns, the average, and now the negative return on investments. Let’s move on to another concept: the internal rate of return on investment (IRR).