Nov 21, 2022

As an investor, the ROI of a property is very important because it can give you a clear picture of the potential returns on a property after all expenses, fees, and taxes.

ROI is an acronym for Return on Investment. Essentially, it means how much profit you will receive in return for the cash investment made. ROI is typically expressed as a percentage of the cost of your investment.

For example, if you pay $400k for rental property and the ROI is 5%, you stand to make $20k in profit.

The purpose of the ROI calculation is to give you a clearer picture of whether your investment will be profitable or not.

Is net income divided by the total cost of the investment.

*ROI = (Net Return / Cost of Investment) x 100 to express as a percentage. *

For example, let’s say you invested $600,000 in the rental property, and the total Gross Return made from the investment is $750,000. The rate of return on your investment is:

*ROI = ($150,000 – $600,000) = 0.25 (x100) = 25%*

Cap rate is not the most accurate way to analyze a short term rental investment, as the value of a short term rental is based on closed comparable residential properties in the area, rather than based on the income of the property. Cap rate is a much more useful calculation for commercial properties.

The cap rate is the ratio between a property’s net operating income and its purchase price.

Net Operating Income / Purchase Price (x 100) = CAP Rate

Purchase Price: $800,000

NOI: $40,000

$40,000/$800,000 = 5% CAP Rate

The CoC is the ratio of the property’s annual NOI and the total amount of cash invested in the rental property. The formula is as follows for CoC:

*CoC = (Annual Cash Flow/Total Cash Invested) × 100%*

For example, let’s say you bought a $200,000 rental property, and you put a 20% deposit and took a mortgage. Your costs will be $40,000 for the deposit, $3,500 for closing costs, and $10,000 for remodeling/fixing up.

The total cash you invested is $53,500 ($40,000 + $3,500 + $10,000).

But remember, when using a mortgage or a loan, you will have an interest payment each month that must be included in your calculation. For example, let’s say that interest is $1000, and your tenant pays $1500 every month.

That means you will have a cash flow of $500 per month.

After one year, your annual return will be $6,000.

Using the CoC formula, we can divide the annual cash flow by the total cash invested in the rental property to discover the ROI.

*Cash on Cash Return = (6,000/53,500) x 100% = 11.2%*

This is your annual return rate on your rental property.

Typically, a good return on your investment property is usually above 10%, but 5% to 10% is also within the acceptable range.

Some investors won’t even consider a property unless the calculation predicts at least a 20% return rate. This is up to you as an investor, and what your metric for a good return rate is.

If you’re in the market for your first rental property or your tenth, the cash on cash return calculation is arguably the best calculation to aid you in choosing the best investment.