The Formula for Calculating Residential Rental Property ROI

As an investor keeping on top of your ROI is a priority. Before jumping into any home purchase, you want to know answers to questions like "how much can I rent my house for," and what will my profitability look like? To better understand whether a property is a great investment for you, it's vital to figure out your ROI for a property. 

What Is the Formula for ROI On An Investment?

Let's start by looking at the basic ROI formula to calculate any investment. Then, we can dive into the specifics and what it means to you as a rental management investor.

ROI (or return on investment) is how much you make on your investment minus the amount you put into the investment (upfront and ongoing), divided by the amount you put into the investment. So, ROI = Earnings gained – Cost of investment ÷ Cost of investment.

As you can see, you'll use one of the numbers twice to find the ROI. The costs associated with the investment will be subtracted from your earnings and divided by that answer. Here is how it looks when constructed like a math problem:

So, an example of the formula for return on investment is as follows:

• If you bring in $1,200 a month, the annual earnings would be $14,400.
• We'll estimate the cost of investment at $210,000
• Your formula calculation would be $14,400 ÷ $210,000 = 0.068 (or 6.8% ROI)

Since ROI is a profitability ratio, it must be represented as a percent. To understand whether this is a good investment, you want to know your ability to earn a profit on this property.

When determining the earning you gained on your rental investment, don't forget this is your gross profit. You would then need to multiply the monthly amount you generate from rent by 12 months to get the annual earnings. The investment cost will be the money you put down or used to upgrade the property plus expenses you pay every month, such as the water utility.

What is a Profitability Ratio?

A profitability ratio is a percentage that gauges how likely you are to earn a profit on the investment. It is used to express your ROI. For most property investments, a rental management advisor will tell you that you're doing well if you are getting above 8%. Of course, 12 % is even better and is the high-end goal of most investors, although this ratio may be challenging to obtain on every property.

Now, back to our example above. We must multiply the final number by 100, which results in 6.8% for the ROI. This is a little on the low side for a good profitability ratio, but there are other factors to consider.

Property Managers Recommend Factors To Consider When Looking at Profitability Ratio

If you cover additional utilities that fluctuate throughout the year, you could compare your profitability ratio during each quarter to see if these costs are dragging down your ROI. For example, if you notice that you are hitting 8% ROI during certain quarters and dropping to 7% or below during one quarter, it makes sense to examine the costs during that quarter.

A property management company can advise that you may need to increase the rent during your lease renewal. The right property manager can also help you find ways to reduce costs and increase profitability to boost ROI.

Property Owners Can Avoid a "Bad" Investment

The best time to avoid a bad investment (and low ROI that never recovers) is before a property owner signs on the dotted line. Real estate investors can avoid a low ROI by having a good property management firm run the numbers for you, so you'll know in advance if a potential property is a winner or not.

Also, residential property managers can research the rental rates in your area, so you charge an appropriate amount and maximize returns. This way, you can look at ROI before you purchase a property. Instead of wondering, "how much can I rent my house for," you'll know the ideal rate for the market.

If you feel you are already in a bad investment situation, there are ways you can turn things around. With the aid of a professional rental property management team, you can bounce back to profitability.