How to calculate out an Return on Investment or ROI.
First of all, what is an ROI? It’s a way of measuring how an investment is or is projected to perform. It is calculated by subtracting all of the annual expenses from the total annual income and then dividing it by the cost of the investment. Our purpose is specifically for rental properties but this same process can be applied to most any investment.
Let’s walk through two examples of the same property and see how vastly different the ROI can be.
First, take the cost of the investment. Costs of investment is $50,000. (at the time this was written we used a property from our website that had these exact numbers. This way you have a Real example).
Next, figure out your gross annual rent. You do this by multiplying the monthly rent by 12 months. Example $800 monthly rent multiplied by 12 months = $9,600 this is your Gross Annual Rent amount.
Next, figure out your Net annual rent amount. You do this by adding up all of your expenses and then subtracting them from your gross annual rent amount.
Here is what I factor into expenses. Examples;
- Taxes (this is a set amount) $1,408
- Insurance $500
- Management fees 10% = $960
- Owner paid utilities (hopefully Zero) $0
- Vacancy Rate 5% = $480
- Repair and Maintenance rate 10% = $960
- Lawn care $0
- Lease Fee (future expense) 3% = $288.
- Add all of these expense up, which equals = $4,596 and this is your total annual expenses.
- Next, subtract your Total Annual Expenses of $4,596 from your Total Gross Rents of $9,600 which Equals = $5,004 This is your Net Income.
- Next, divide your Net Income of $5,004 by the Cost of the Investment which is $50,000.
- $5,004 Divided by $50,000 = 10.008% ROI.
- The Example above shows a 10% Return On Investment. This scenario was taken directly from the Partners Investing Website.
Second Example (Typical of other sites)
Let’s take this same investment property and figure out the ROI using the most common expenses that you’ll see on other websites.
Assuming they are selling the property for the same amount. Cost is $50,000. Monthly rents of $800 X 12 months = $9,600 Gross Annual Rent.
Most Common List of Expenses;
- Taxes of $1,408
- Insurance of $500
- 10% property management fee of $960
- Plus Owner paid utilities of $0
- Add all of the expenses up, which equals = $2,868 and this is your total annual expenses.
- Next, subtract your Total Annual Expenses of $2,868 from your Total Gross Rents of $9,600 which Equals = $6,732 This is your Net Income.
- Next Divide your Net annual income of $6,732 by the cost of the investment which is $50,000.
- $6,732 Divided by $50,000 = 13.46% ROI.
- Wow! Big difference. Should I be advertising a 13.46% or a 10% ROI?
Okay, what was left out of the second scenario?
- Vacancy Rate of 5% = $480 - Just because it's rented now doesn't mean it always will be. I have 5% in there which accounts for a vacancy every two plus years.
- Repairs and Maintenance Rate of 10% = $960 - With my properties all of the Major CAPEX items are taken care of but that doesn't mean there won't be routine maintenance and random repairs.
- Lease Fee Rate of 3% = $288 - Need to account for the future lease fee as it will eventually go vacant. I have 3% in there which accounts for a new tenant every 2 plus years.
- Total amounnt of expenses left out is $1,728. This is typical from other turn key property sites.
So this same investment can show an ROI of 10% or 13.46% depending on what is factored into the expenses. I’m not saying other websites are wrong. What I’m saying is make sure you are comparing Apples to Apples. When you see an advertisement for a specific ROI, pause for a moment and see what all is included when they figured out their ROI.
I highly recommend you create your own spreadsheet (excel seems to be the best for this) and then run the different investments you come across through it and that way you’ll know for sure your comparing apples to apples. This will help you start to see patterns and then you’ll know when it’s a good deal.
I hope this helps, if you have a specific question please feel free to send us an email.