In these days of limited resources, individuals and investors are interested in putting their money in the best-performing asset class. Investment options have increased over the years. We are no longer dealing with traditional and tangible options but also digital ones. So, how does one measure the viability or profitability of their investment?
The return on investment (ROI) is the numerical tool used to make such an analysis. In this guide, we will be analyzing the ROI from a property perspective and guiding property investors (both current & future) on what they should be expecting from their assets.
The experienced and expert crew from Vineyard Property Management have condensed their experience to guide landlords in Cherokee & Cobb Counties.
What is ROI?
This is a financial numerical metric used by investors to evaluate an investment opportunity and also assess its profitability to other viable options. The ROI compares the return to be obtained from the specific asset taking into consideration initial investment outlay, maintenance, and income.
The return to be enjoyed from property is a measure of its risk. To properly advise the wide range of clients reading this article, we would have to assess this from the various property types in play.
Long-Term Rental Options
A long-term rental property can be described as the type of real estate that is leased out for a period of close to one year and more. Such types of properties include apartments, condos, multi-family residential, retail, and commercial buildings. A tenant who leases such a space will provide you with a steady rental income over the months with minimum issues.
As you can imagine, this type of tenant is a low-risk type. They will maintain the space well, pay their rent on time, and comply with the terms of the rent. The appropriate rate of return for such an option is typically between 8% to 12%.
Short-Term Rental Options
In this type of property, the property is leased out for a very short period, often less than a month. The increased demand for short-term properties has increased over the years thanks to the uptake of vacation platforms such as Expedia, Booking, and Airbnb.
Due to the short-term nature of the residency, landlords tend to charge higher than the normal rent. The costs incurred are also higher in terms of cleaning, maintenance, and management. During peak seasons, landlords can enjoy a return of close to 20% or more. The same figures can dip to single-digit figures during low peak seasons.
You should be aware that the rate of return for both long and short-term options varies depending on several factors. Location, property type, demand, property management, operating expenses, and local taxes all play a role in the return for the property.
Calculating ROI
When it comes to calculating the ROI, there are three typical ways:
Method 1
The follow for Method 1 is as follows:
ROI = ((Investment income – Initial cost of investment) / Initial cost of investment) *100
Example: If you sunk in $100,000 to purchase a rental property, and the profits made from the same property amount to $120,000, the ROI can be calculated as follows:
ROI = (($120,000 - $100,000) / $100,000) * 100
= 20%.
This is the simplest formula for calculating the ROI. The calculations are very generic. Below are more detailed methods.
Method 2
This method uses the cap rate to analyze the performance of an asset. It is mainly used by investors who are comparing the viability of investing in a property, especially when they have several to choose from. This method is most suitable for commercial and long-term residential properties. It is not ideal for short-term rental options.
For you to better understand the method, here is the method broken down into two steps:
Step One: Calculating Net Operating Income (NOI)
Net Operating Income (NOI) = Gross Rental Income (GRI) – Operating Expenses
Step Two: Calculating Cap Rate
Cap Rate = (NOI/ Purchase Price )* 100
Example: You spent $300,000 to purchase a residential property in the suburbs. You also spent $1,500 and $10,000 on closing costs and remodeling respectively. Your total costs for investing in the property total $311,500.
From the tenants on the property, you will receive $12,000 annually. You will incur costs in taxation, maintenance, and management which total $2,000. The cap rate can be calculated as follows:
NOI = $12,000 - $2,000 = $10,000
Cap rate = ($10,000/ $311,500) * 100 = 3.2%
Method 3
This method is the most complicated of the three and is also known as Cash on Cash Return or CoC. It is a ratio of annual NOI/ Total Cash Invested. See the example below.
You bought a rental property worth $300,000 and also put in a 10% deposit for a mortgage. The costs incurred would be $30,000 for the deposit, $3,500 for closing costs, and $10,000 for renovations. The total was $43,500.
From the property, you will be receiving $1,500 every month. But you will also be paying interest payment for the mortgage which we can assume is $1,000. Cash flow will be at $500 every month; $6,000 every year.
Using the formula:
CoC = ($6,000/ $43,500) * 100 = 13.79%
Conclusion
Are you ready to put your resources into the rental investment market? You should first perform a thorough assessment and analysis of the ROI. Collect all the necessary information that you need from the property and the neighborhood before making the final decision.
Receiving expert support and advice during the purchasing process is key for any investor. In most cases, potential and future investors lack the expertise required to properly assess and perform the necessary calculations. That’s where having an expert by your side can come in handy at such a time.
Our company is known for its leading, industry-based solutions. We keep in touch with the latest standards through the National Association of Realtors & the National Association of Residential Property Managers.
Get in touch with Vineyard Property Management and receive a quote for your inquiry.
