Things to Consider Before Purchasing Investment Property
ROI - Return on Investment
Real estate investors often see positive cash flow with their investment properties in today’s market, but the savviest investors calculate their approximate return on investment (ROI) rates before purchasing a property. To calculate your ROI on potential property investments, follow the steps outlined below:
Estimate Your Annual Rental Income
Search for similar properties currently up for rent in your area. Find an average monthly rent for the type of property you’re interested in and multiply that rent price by 12 for a year’s worth of income.
Calculate Your Net Operating Income
Estimate your potential annual rental income then calculate your net operating income. Your net operating income is equal to your annual rental estimate minus your annual operating expenses. Your operating expenses are the total amount of money it takes to maintain your property every year.
These expenses include homeowners insurance, property taxes, maintenance and homeowners association (HOA) fees. Don’t include your mortgage loan or interest in your net operating expense calculation. Subtract your operating expenses from your annual rent estimation to find your NOI.
Find Your ROI
Finally, divide your NOI by the total value of your mortgage to find your total ROI. Your ROI helps you understand whether you should invest in one property over another. It can also give you an idea of your real estate investment’s profitability.
ROI Example Calculation
If you buy a $200,000 property you can rent out for $1,000 a month. Your total potential income is $1,000 × 12 months for a total of $12,000. If you assume that the property costs about $500 a month in maintenance fees and taxes the following would calculate the ROI.
- $500 × 12 = estimated operating expenses of $6,000.
- Subtract your operating expenses from your total rent potential: $12,000 − $6,000 = $6,000 of net operating income.
- Divide your NOI by the total value of your mortgage: $6,000 ÷ $200,000 = 0.03, which makes this property’s ROI 3%.
If you buy a property in a solid area and know you can rent to reliable tenants, a 3% ROI is great. However, if the property is in an area known for short-term tenants, a 3% ROI may not be worth your time and effort.