How to Calculate ROI on a Rental Property in 5 Steps

Whether you own a rental property or hope to purchase your first, you must measure the profitability of your investment. You can use this knowledge to determine whether sinking more money into a rental is the right choice. Continue reading to learn how to calculate your rental property ROI, including other formulas you can use to estimate your investment’s return rate. 

What is Return on Investment (ROI)?  

Return on Investment (ROI) is a metric that estimates an investment property’s revenue gains as a percentage of the investment’s cost. Essentially, it determines if your investment was profitable. Whether you’re a seasoned property owner or a newcomer to the industry, knowing the ROI of a rental property can help you determine if putting more money into an investment is the right call.   

How to Calculate ROI on a Rental Property 

Here are five steps to accurately calculate your rental property’s ROI: 

1. Collect your expenses data 

Before calculating the property’s ROI, collect your upfront and recurring expenses. To help track these costs, consider using our online expense tracking platform and keep everything in one spot. Upfront costs are usually one-time payments, such as: 

• Down payment
• Closing costs
• Repairs
• Renovations
• Interest rate

You must gather your recurring expenses and compare them against your rental income or cash flow. Some of these ongoing costs may include: 

• Property or landlord insurance
• Taxes
• Property maintenance
• Homeowners association fees (HOA)

2. The ROI formula  

To get a property’s ROI, calculate your net profit with the following formula: 

• Net profits = investment gain – investment cost

After calculating your net profit, divide it by the original cost of the rental investment property. Here is what the formula looks like: 

• ROI = (investment gain – investment cost) ÷ investment cost 

OR 

• ROI = net profits ÷ investment cost

For example, if you bought a property for $100,000 and sold it a year later for $150,000, then your net profits would be $50,000 ($150,000 - $100,000). Therefore, the ROI for this property is 50% [ $50,000 (net profits) ÷ $100,000 (cost) = 0.50]. 

3. ROI for cash transactions  

Calculating the ROI for a rental property is easiest when you pay for it with cash. For example, if you paid $250,000 in cash for the property, with $2,000 for closing costs and $20,000 for renovations, then the total cost of the investment is $272,000. Assume you collected $1,500 in monthly rent payments.   

In one year, you earned $18,000 in rental income (from a 12-month lease) and paid $3,000 in expenses ($250 monthly for water, sewer, insurance, etc.). Your net profits would be $15,000 ($18,000 - $3,000).   

To calculate the ROI for this cash transaction, input your data into the formula.  

The ROI for your cash-paid rental property = $15,000 (net profits) ÷ $250,000 (investment cost) = 0.06 or 6%. 

4. ROI for financed transactions  

Calculating the ROI of a mortgaged financial rental property is a little more intricate. For example, assume a rental property costs $250,000, and you paid 10% with your down payment or $25,000. The closing costs were $3,000, and you sank an additional $5,000 for remodeling. Your total out-of-pocket expenses would be $33,000 ($25,000 + $3,000 + $5,000).   

You must also consider the recurring costs that come with having a mortgage. If you took out a standard 30-year loan with a 5% fixed interest rate, your monthly principal and interest payment on the $225,000 loan would be $1,208. Including the $250 monthly expenses, your total monthly mortgage payment is $1,458.  

If your rental income is $2,000 a month, that equals $24,000 annually. With a monthly cashflow of $542 ($2,000 rent - $1,458 mortgage payment), your annual cash return would be $6,504.  

Now that you have your numbers, you can calculate the ROI.   

ROI = $6,504 ÷ $33,000 = 0.197  

Your rental property’s ROI is 19.7%.   

5. ROI with home equity  

Equity represents your rental property’s market value minus the outstanding loan amount. It is not on-hand money for you to withdraw on a whim. It is only an estimated value until you sell the property.   

To add equity into your ROI estimate, calculate how much equity your property has by reviewing your mortgage amortization schedule. As you make your mortgage payments, you build equity. Once you have your equity amount, add it to the annual return.   

For example, the amortization schedule for your loan shows you paid down $2,000 of principal during the first year. Therefore, your new annual return with equity equals $8,504 ($6,505 annual income + $2,000 equity). Now input your data into the ROI formula, like so:  

ROI = $8,504 ÷ $33,000 = 0.257  

Your rental property’s ROI is 25.7%. 

Considerations Regarding ROI Calculations  

When calculating a meaningful return on investment, do not underestimate the cost of your expenses. As a property owner, it’s natural to want to minimize your expenses and set aside the bare minimum for ongoing costs. But consider vacancies, too, because you still must pay your recurring expenses even when the property is vacant (i.e., no cash flow).  

Remember, you want your numbers to be as accurate as possible. From property taxes to insurance to HOA fees, you need a clear idea of how much each expense will cost. When in doubt, estimate up. To be safe, estimate slightly down when calculating your rental income.. Here are some other industry recommendations to consider: 

• No more than 10% of rental income should go towards vacancy-related expenses, such as lost rent, online marketing, and real estate agent fees.
• No more than 10% of rental income should go to the maintenance and repairs of a new rental unit.
• No more than 25% of revenue should go to expenses for old and unkempt rental properties.

Why is ROI Important for Rental Properties?  

ROI is important for rental real estate because it informs landlords about the profitability of potential investments. Whether you’re a seasoned real estate investor or new to the field, you should always estimate your expenses, costs, and rental income before buying a property. Once you have your numbers, you can more accurately determine if a rental property is worth your money.  

If you already purchased the property and realize your expenses outweigh your ROI, then there are two important things to consider: 

1. You can wait it out and hope your rental property is profitable again.
2. You can sell your real estate investment before you lose too much money and property value.

What is a Good ROI for a Rental Property? 

Generally, a good rental property ROI should be 15% or higher. However, the exact standard for what is a good ROI can vary. Investors gauge a positive rate of return based on factors like rental prices, location, investment risks, etc. If the return rate is at least 10%, that’s typically an excellent place to be. But some rental investors might not look at a property if their calculations indicate it won’t provide at least a 20% return rate.

Be mindful that if your ROI is zero or negative, the property costs you money (i.e., your expenses exceed your profits). 

Other Methods to Calculate Return Rate  

When you want additional security for your investment profits, here are a few other ways you can calculate a rental property’s return rate. 

Annual cash flow  

You can see your yearly cash flow by subtracting your mortgage payments and expenses from your annual rental income. If money is left over at the end of each month, you’ve got positive cash flow. Your cash flow is negative if you don’t have any money at the end of each month. Here’s the formula: 

• Annual cash flow = rental income - mortgage payments – expenses

Gross rent multiplier (GRM) 

The gross rent multiplier is a metric you can use to compare rental properties within a specific market. You can calculate the GRM by dividing the property’s sale price by the yearly gross rent. For example, if you purchased a home for $200,000 and the annual gross rent is $26,000, then the GRM is 7.69. Here’s the formula: 

• GRM = property sale price ÷ annual gross rent

Cash-on-cash return (CoC) 

The cash-on-cash return metric evaluates the income your rental property generates compared to the amount of cash you invested. You calculate the return rate by dividing the pre-tax yearly cash flow by the invested money. For example, if you paid $100,000 in cash for the rental property and your annual pre-tax cash flow is 12,000, the cash-on-cash return rate is 8.3%. Here’s the formula: 

• CoC = pre-tax annual cash income ÷ cash invested in property

Net operating income (NOI) 

NOI measures how profitable an investment will be without using leverage. Leverage is when an investor borrows money to purchase a property, with the primary objective being to increase their returns. You calculate NOI by subtracting the operating expenses from your gross yearly rental income. For example, if a home generates $20,000 in rental income annually and the operating costs are 25% of the rent, your NOI is $15,000 ($20,000 – $5,000). Here’s the formula: 

• NOI = gross annual rental income – operating expenses 

Cap rate  

The capitalization rate (cap rate) measures the rate of return for multiple rental properties. You calculate this estimate by dividing the NOI by the property’s purchase price (i.e., its asset value). For example, if you purchase a rental investment for $275,000 and the NOI is $15,000 for the first year, your cap rate is 0.054 or 5.4%. Here’s the formula: Cap rate = NOI ÷ property purchase price 

• Cap rate = NOI ÷ property purchase price 

Downside of Only Using ROI  

If you only use ROI to estimate a rental property’s value, you’re limiting your ability to comprehensively review a property’s profitability. You could lose money or, worse, your entire real estate investment. Whether you use a cap rate analysis or annual cash flow metric, several return rate formulas help you make more informed decisions about the assets you invest in. 

Frequently Asked Questions