A smart investor understands the concept of Return on Investment (ROI), and applies ROI calculation tools to a prospective investment property in order to better understand the potential success of their rental purchase.

Although there are many ways to calculate ROI, including Internal Rate of Return (IRR), Capitalization Rate (Cap Rate), Debt Coverage Ratio (DCR), Gross Rent Multiplier (GRM), Cash on Cash Return (COC), these ratio tools are commonly used for more sophisticated investing of commercial properties. For the investor of single family or small multi family rental properties, a simpler formula to calculate ROI may be used.

A simplified calculation of ROI therefore would look like this:

Very simply put; take the sales price (or anticipated sales price and subtract the original cost, plus any additional out of pocket expenses (or anticipated out of pocket costs). Then divide by the original cost to get your Return on Investment.

An example of ROI on a residential investment property would look like this:

If you purchase a home for $100,000 and put 20% down, and if you anticipate a 5% appreciation over 10 years, assuming your cash flow will cover all expenses without taking any income over this period, your ROI would be:

** Assume $800/ month rent, $200/mo taxes and insurance, 5% mortgage.

In this simple calculation, important considerations such as the effect of taxes and depreciation, and increased equity due to principle payments are not considered. However it is a useful beginning point. A more detailed analysis should then follow which would take other more in depth considerations into account. For help in calculating ROI contact our office for a Free Analysis of your prospective rental investment.

It is critical to the success of your investment to plug accurate assumption numbers (preferably conservative) into your ROI calculation. This includes getting an accurate Rental Analysis by a qualified Rental Property Manager as well as taking steps to insure proper professional oversight of your investment which includes preventing property damage and loss due to poor tenant selection and regular property inspections.

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