Hello, property and potential property owners! Welcome to the RPM Distinguished Care blog, where we provide practical advice about property management! If you’re a return visitor, welcome back and we appreciate your support! RPM Distinguished Care specializes in managing successful rental properties in and around the Charleston area. We’re here to make your lives easier by giving you the resources you need to maximize profitability and have a successful rental property. If you haven’t already, make sure you check out our previous posts about what to keep in mind when choosing a rental property and the Charleston rental market. Our most recent article delves deep into what makes Charleston an idyllic city for rental investment, as well as forecasts by experts about what the next five years will bring in terms of jobs, affordability, and cash flow!
Choosing the right location has a direct impact on the success and profitability of your rental property, but there are a host of other factors which also determine profitability. How do you assess the potential profit of a rental investment? And how do you capitalize on and increase those profits in the long term? Well, today’s article is all about return on investment (ROI). We’ll walk you through a bit of simple math and then on to what you can do as a property owner to maximize the profits from your investment. Everyone has different goals for their rental investment, whether that’s supplementing income or saving money for a special event, and we want to help you reach those goals. If you’re not sure where to start, read on!
What is Return on Investment?
Return on investment, also sometimes referred to as return on costs (ROC), is a metric used to gauge how well an investment is performing. In order to assess whether the investment was worth the money, a ratio is calculated using the initial capital and the amount of profit made over a period of time. Many investors use return on investment to decide whether or not to continue investing in certain securities. Or, on a smaller scale, many people use return on investment to judge which bank to open a savings account with. Of course, savings accounts with higher interest rates yield higher returns and are thus more attractive to savers. Everyone wants to know their money is being put to good use, but how does one determine the return on investment ratio before placing their money into an investment?
If you’re still shopping around for rental properties or weighing the decision to become a rental property owner, this is the best time to perform a few calculations which will help you in the long run. Depending on how you plan to buy your rental property, these calculations can differ greatly.
The first formula is simple and can be used for any type of investment, not just property. This formula will yield a percentage, as we’re determining a ratio.
Net Gain / Total Cost = Return on Investment
For example, if you spent $3,000 purchasing stock from XYZ company and sold it after five years, when the stock was valued at $7,000, your net gain would be $4,000. When you divide the net gain by the total cost, or $7,000, you arrive at the return on investment: 57%. In those five years, you’ll have gained fifty-seven percent in excess of the money you initially invested.
Now, for a rental property, the equation has more variables to take into account. Maintenance costs, down payments, and financing all affect the way return on investment is calculated for rental properties. If you plan to pay with cash, things are simpler. For example, say the property costs $130,000. Let’s estimate the closing costs and remodeling total about $15,000. You plan to charge $1,450 per month, which means in a twelve month time span you’ll collect $17,400 in rent. Property taxes and insurance came to $2,600. The important figures, at a glance, are:
- Purchase Price: $145,000
- Net Return: $14,800
Now, in order to calculate the return on investment for this property, you’ll follow the same formula we performed above. By dividing the net return by the total investment, you’ll arrive at the right ROI.
$14,800 / $145,000 = 10.2%
Wonderful! You can use this formula to easily project potential returns. However, if you’re purchasing a rental property using traditional financing, there are even more calculations to perform before you’ll be able to determine ROI. First, you must factor in the down payment. Let’s continue the cash example, but say the down payment for the $145,000 property is $29,000 (or 20%). Let’s up the closing costs to $2,700; which, when combined with remodeling, total about $16,700. As well, there’s the interest on the loan. Here is where things can get tricky.
Assuming a 30-year loan term and an interest rate of 3.5% on the $116,000 borrowed, the monthly mortgage payment would be $521 per month or $6,252. Let’s add on the same property taxes and insurance. As well, let’s keep the rent the same. After a year, the important figures are:
- Purchase Price: $74,700 (Keep in mind, the purchase price does not include the full price of the property, only the out-of-pocket expenses you incurred. This figure includes the down payment, closing costs, and renovation expenses.)
- Net Return: $11,148 (We determine net return by subtracting expenses—such as taxes, insurance, and mortgage payments—from the rent paid.)
Keep in mind, the purchase price does not include the full price of the property, only the out-of-pocket expenses you incurred. Using these figures and the same ROI formula, the equation is:
$11,148 / $74,700 = 14.9%
Now, some property owners also take into account equity. To do this you would need to review your mortgage amortization schedule, however. For today, we’ll leave things here. Congratulations, you know how to calculate and project a rental property’s return on investment! Now, how do you increase return on investment year after year?
The Principles of Profitability
If there are a set of hard and fast rules to making a rental property highly profitably, we haven’t found them yet. We’re only privy to a few general rules of thumb which contribute to successful properties. Of those, there’s planning, diligence, and creativity.
To begin with, maximizing the profitability of your rental property begins before you’ve even chosen the property. This is where planning comes in. Do ample research about the area you’re buying into. We have an article called, ‘What to Consider When Choosing a Rental Property,’ which walks you through the deciding factors step-by-step. Perform calculations. When you’ve determined a ballpark budget, you’ll be able to estimate yearly maintenance costs, monthly rents, mortgage payments, and return on investment. Planning for the long-term health of your finances will help ensure a successful investment.
Doing your due diligence can mean screening tenants carefully before offering leases (check out our article on ‘How to Properly Vet Tenants’) or hiring a professional property manager to handle this process for you. If this is your first rental property, the expertise of a property manager can go a long way towards contributing towards profitability. Likewise, if this is one of several rental properties you own and you’ve reached the point where you can no longer give adequate time to each, the services of a property management company can keep you from potentially losing tenants and profits.
Finally, there’s creativity. Many profitability solutions require a bit of creativity from the owner. From remodeling to allowing pets, there are a number of ways you can keep tenants in units and market your listings successfully. If you live in an area with lots of young people, take heed of research which shows they’re predisposed to want shorter term leases. Being creative requires you to place yourself in the position of the tenant and imagine what they want. New light fixtures? A security system? Landscaping in the front yard or a patio out back? Fully furnished units? Consider what more you could do to make tenants happy. That said, don’t be afraid to charge necessary fees. Application fees and pet fees and extra occupant fees are common methods used by landlords not just to enforce certain standards, but to cover other expenses associated with the property.
We support your desire to boost your rental property profitability and hope this article has given you the fundamental information to do so. Use the return on investment formula to strategize and plan for the future! With Real Property Management Distinguished Care, we treat your property as if it were our own. No hidden fees, only safeguards and guarantees. Up-front packages you can review and prepare for right here on our website! If you’d like more information on how we address and plan for maintenance, don’t hesitate to reach out. We are more than happy to assist you in setting up the perfect property management service for your properties. Protecting your investments is our priority!
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