There are a lot of questions you may have when looking to buy your first rental property. Where should I buy? Is this a good time to invest in a rental property? What are my legal responsibilities as a landlord? These are important questions to ask before you invest the time and money into a rental property. Property is a big investment and there is a lot for a first-time buyer to learn. Let’s take a look at a very important question when looking at rental properties and deciding how much to charge for rent.
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What is Rate of Return?
Rate of return is used to determine the efficacy of an investment. You don’t want to invest so much money into a property if it’s not going to make enough money in return. Rate of return is also called return on investment.
What is a Good Rate of Return/ROI
A good rate of return can vary from place to place. This is because of several different factors at play. These factors include the real estate values in your area and how you purchase the property. Many experts can agree though that a good rate of return falls between 8 and 12%. Some very good investments can reach 20% or more. Make sure to check your local market before investing in a property.
How to Calculate Rate of Return/ROI
There are a few different formulas to calculate the rate of return based on how you buy the property and the current market. Let’s take a look at a few different formulas.
The Simple Formula
- ROI=(Gain from Investment – Cost of Investment)/Cost of Investment
- This is a general formula, but not always the most accurate. This formula is a good starting point for calculating your ROI.
Cap Rate Calculation
- The first formula you need for this is Net Operating Income(NOI) = Rental Income-Operating Expenses
- Cap Rate = NOI/Purchase Price x 100%
- The purchase price also includes any closing fees and initial updates that the property needs, such as remodeling.
- This formula is commonly used by investors paying cash for their properties.
Cash on Cash Return Formula
- CoC = (Annual Cash Flow/Total Cash Invested) x 100%
- Total cash invested would be things like down payments, closing costs, and any updates/remodeling done on the property.
- Annual cash flow is monthly rent minus mortgage payments times 12.
- This formula is more complicated to use. It is used when a real estate investor is buying a property using a mortgage rather than paying cash up front.
Why Does it Matter?
To have a successful rental property investment, you need to know how much you bring in a month and if that is in line with other properties in your area. With too low of an ROI you won’t be making enough money to justify the cost. In this case, if there are any repairs that are needed you may not have the funds for them. With too high of an ROI you may struggle to find renters who want to pay more than the average costs for the area.
The rate of return is an important thing to consider when buying an investment/rental property. This goes for both first-time investors and longtime investors. Greater Nashville Title can help you navigate the buying process and help with the legal work of investing.
Buying property doesn’t have to be a difficult process, let us help you. Visit our website to learn more today!