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How to Calculate ROI on Rental Property
Investing in real estate is one of the most reliable ways to build wealth, but understanding your Return on Investment (ROI) is crucial before signing any contracts. This Rental Property ROI Calculator helps investors analyze the profitability of a potential purchase by breaking down cash flow, capitalization rates, and cash-on-cash returns.
Understanding Key Investment Metrics
When evaluating a rental property, there are several key formulas used to determine if a deal is financially sound:
- Cash on Cash Return (CoC): This is arguably the most important metric for rental investors. It measures the annual pre-tax cash flow divided by the total cash invested (down payment + closing costs). A CoC return of 8-12% is generally considered good in many markets.
- Net Operating Income (NOI): This represents the total income the property generates minus all necessary operating expenses (taxes, insurance, maintenance, vacancy), but before mortgage payments. NOI is essential for calculating Cap Rate.
- Cap Rate (Capitalization Rate): Calculated by dividing NOI by the property's purchase price. It helps compare the profitability of different properties regardless of how they are financed.
How to Use This Calculator
To get the most accurate results, ensure you input realistic numbers:
- Purchase Price & Loan: Enter the negotiated price and your loan details. Interest rates significantly impact your monthly mortgage payment and final cash flow.
- Income: Input the expected monthly rent. Be sure to account for vacancy; a standard vacancy rate is often estimated at 5% to 8% (roughly one month empty per year).
- Expenses: Don't underestimate expenses. Property taxes, landlord insurance, and a maintenance fund (usually 1% of property value per year) are mandatory costs. If the property has an HOA, include that in the annual maintenance field.
Example Calculation
Imagine purchasing a property for $200,000 with $40,000 down (20%). If your closing costs are $3,000, your total cash invested is $43,000. If the property generates $10,000 in net profit (after mortgage and expenses) per year, your Cash on Cash return would be:
($10,000 / $43,000) * 100 = 23.25%
Using a calculator ensures you don't miss hidden costs that could turn a profitable deal into a financial liability.