Many rental property investors focus so much on "how much can I rent my house for" and monthly cash flow that they overlook the more pressing question of long-term ROI. Since rental properties are long-term investments, it's critical to make sure that short-term goals and metrics contribute to future income goals.
Maximizing returns requires careful calculations that include rent collection and several other factors, including better tenant retention. The best property management company Detroit offers has insights into calculating ROI when paying cash-in-full for an investment property. The right property managers can also help you with property management services to optimize returns.
ROI Terms and Definitions
Before diving into calculating ROI for cash transactions, it's essential to understand the terms and definitions that apply to the formula. These are:
ROI. Return on Investment.
Cost of investment. This figure includes the purchase price of the property (without financing) and the cost of renovations or upgrades before the tenant moved in.
Expenses. With a cash-purchased property, ongoing costs include taxes, insurance, HOA, fees for rental management services, and any utilities you pay.
Earnings gained. This is the amount of rent collected annually.
Net profit. After deducting expenses from the rental payment, the amount left is your net profit.
Profitability ratio. This is the percentage used to express ROI for a rental property.
With these terms in mind, we'll look at why ROI matters and how to calculate it for a property purchased without financing.
Should You Worry About ROI?
A property manager can tell you that ROI is an important factor to an investor because it indicates whether a property will yield enough money to be profitable after expenses. When rental property owners build a portfolio of investment properties that don't bring in enough ROI, then, in time, those businesses may go under. Beyond answering the question, "how much can I rent my house for," owners need to look at the expenses plus the initial upfront amount they paid to determine profitability.
What is the Difference Between ROI For a Cash vs. Financed Rental Property?
While not all investors build a portfolio this way, some investors purchase properties with cash, meaning they don't take out a mortgage or other loans to finance a property and pay for rental-ready upgrades. When figuring out the ROI for a cash transaction, it is simpler because you don't have to calculate the interest on the mortgage or factor in monthly mortgage payments.
A financed transaction on a rental property simply means you purchase the property by taking out a mortgage that must be paid every month.
How Do I Calculate ROI on a Cash Transaction?
When calculating ROI for a cash transaction, the first step is determining the amount you spent upfront. Property owners should add the cost of the property along with any money they put into getting a property ready to rent when defining the cost of investment.
Then, determine the amount for monthly expenses. This number would include the items mentioned above, such as utilities, taxes, property management fees, monthly maintenance costs, and more.
Now let's look closer at the ROI calculation for a cash transaction by using a "real-life" example:
You paid $155,000 in cash for a new rental property, then upgraded the home, spending $9,500. Your cash out-of-pocket is $164,500 as your cost of investment.
You charge $1,700 per month for rent (or $20,400 annually) and have $200 in expenses (or $2,400 annually).
Subtract the annual expenses from the total annual rental income. This comes out to a net profit of $18,000 annually.
To learn the property's ROI, divide the net annual profit by the investment cost ($18,000 ÷ $164,500 = 0.10). Then, convert this to a percent (or profitability ratio) by multiplying by 100. The ROI is 10%.
Other Factors to Consider
Is 10% a good ROI for Metro Detroit rental properties? Property management companies will tell you that generating an ROI between 8–12 % is a good place to be when considering potential profitability for an investment. However, if your ROI is on the low side, a property owner can do some things to improve it.
ROI numbers will fluctuate over time. If you own multiple rentals, a low ROI for one property can be offset by a high performer to balance your rental property portfolio returns. However, if the returns for a property stay low for too long, work with a property management company to reevaluate the monthly rent price, improve tenant retention, and make other strategic changes to improve ROI.
Understand and Improve ROIs With a Detroit Property Management Company
Detroit property management companies can help investors run the numbers and optimize returns for rental properties. If you're struggling to find the right mix of the best rental rate and strategic practices for long-term success, Own It Detroit is here to help! Whether you have five, fifty, or five-hundred properties, it's important to monitor returns for each one. Reach to speak with one of our seasoned real estate experts to learn how our professional property management services can boost your long-term returns and success.
Find a property's ROI with our free Rental Property ROI Calculator!