October 20, 2023 1:31 pm

Insert Lead Generation
Nikka Sulton

How do you calculate ROI on BRRRR? Investing in real estate can be driven by various goals, whether it’s long-term financial security, saving for important life events, or generating extra income. These goals all boil down to one common objective: financial growth.

In real estate, the path to wealth accumulation can take different forms over time. If you opt for residential rentals, you might focus on appreciation, equity growth, and cash flow. On the other hand, shorter-term gains can be pursued through strategies like BRRRR or fix-and-flips.

Regardless of your chosen investment strategy, savvy real estate investors assess a property’s profitability by considering Return on Investment (ROI). Understanding ROI, being proficient in its calculation for rental properties, and acknowledging its importance are fundamental aspects of making informed decisions in real estate investment.

This guide offers a comprehensive exploration of rental property ROI, shedding light on its potential to pave the way for success in real estate investment.

 

What is BRRRR?

BRRRR, which stands for Buy, Rehab, Rent, Refinance, Repeat, is a strategic approach to real estate investment.

Most investors usually opt for a loan when acquiring a property. However, experienced investors know there’s a more efficient way to go about it.

Think of it this way: if your crush requested a picture of you, would you send one without first ensuring you look your best? Probably not. Just like in personal presentations, in real estate investing, it’s crucial to make sure your property is in its prime condition before seeking a loan. Taking out a loan and then renovating the property is like sending that picture before getting all dolled up. This post explains why this sequence matters, how it benefits your financial outcomes, and why top-notch investors embrace this strategy.

 

What Is Return on Investment (ROI) on a rental property?

How do you calculate ROI on BRRRR? Return on Investment (ROI) is a crucial metric for gauging the profitability and effectiveness of investments, revealing how investment funds translate into monetary gains.

Whether you’re investing in stocks, bonds, savings accounts, or real estate properties, ROI serves as a standardized measure to evaluate the wisdom of allocating funds to a specific investment. In the realm of real estate, where diverse investment options abound, comprehending and computing ROI becomes pivotal for making well-informed decisions.

However, determining a meaningful and practical ROI for investment properties, especially rental properties, can be challenging due to the multitude of variables that affect the calculations. These variables include the method of purchase (cash or mortgage), operating costs, expected cash flow, and potential renovation expenses.

 

How To Calculate ROI On A Rental Property?

ROI, which stands for return on investment, signifies the rate of return you can anticipate from your investment. When someone talks about earning a 10% return on their investment, they are essentially talking about ROI. In real estate, this is often referred to as “cash on cash.”

Now, let’s delve into a bit of math (but don’t worry, it’ll be concise). To calculate ROI, you simply take your yearly profit and divide it by the amount you’ve invested.

In the context of real estate, you’d take your monthly cash flow, multiply it by 12 (to annualize it), and then divide it by your down payment.

 

(Cash Flow x 12) / (Down Payment)

 

It’s as straightforward as that. Two basic numbers in the formula, making it easy to grasp. Understanding this concept is essential because as investors, our aim is to enhance our ROI. If you can’t comprehend something, you can’t enhance it, which is why they say knowledge is power.

When evaluating rental properties, ROI is often calculated by subtracting the annual operating costs from the annual rental income and then dividing this figure by the mortgage value or the remaining loan amount. The formula for this calculation is quite straightforward:

 

ROI = (ANNUAL RENTAL INCOME – ANNUAL OPERATING COSTS) / MORTGAGE VALUE

This simple calculation gives you an estimate of your investment’s profitability or potential losses. Alternatively, there’s the cap rate method, which uses this formula:

CAP RATE = NET OPERATING INCOME / PURCHASE PRICE × 100%

The cap rate considers both the net operating income and the property’s purchase price. Another approach is the cash-on-cash return, calculated as:

CASH-ON-CASH RETURN = (ANNUAL CASH FLOW / TOTAL CASH INVESTED) × 100%

This formula takes into account the annual cash flow generated by the property and the total cash investment.

It’s crucial to choose the method that best suits your rental property analysis. If you prefer to use a financial calculator, tools like the Landlord Studio rental yield calculator can be a helpful resource.

 

What Is A Good Rate Of Return On A Rental Property?

The rate of return on your real estate investments can vary significantly based on various factors. These factors include your initial investment, rental income, location, and local expenses like property taxes, management fees, and financing.

In the end, what constitutes a “good” ROI depends on your specific rental business setup and objectives. Nevertheless, as a rough estimate, many investors target an ROI ranging from 8% to 12%.

 

Examples: Calculating ROI on Rental Properties

Although the equations mentioned earlier may seem simple, it’s crucial to consider how real estate variables can affect ROI calculations. Variables like repair and maintenance costs, as well as your financing and leverage, can have a significant impact on ROI figures. To illustrate, let’s explore two examples of calculating ROI for a rental property.

 

ROI for Cash Transactions

Calculating a property’s ROI is relatively straightforward when you purchase it with cash, as there are fewer variables to consider. Here’s an example of a rental property bought with cash:

 

  • You invested $125,000 in cash to acquire the rental property.
  • Closing costs amounted to $1,250, and renovation expenses added up to $11,250, resulting in a total investment of $137,500 for the property.
  • You collected $1,250 in rent every month.

 

A year later:

  • You earned $15,000 in rental income over 12 months.
  • Recurring expenses, including water bills, property taxes, and insurance, totaled $3,600 for the year, or $300 per month.
  • Your annual return was $11,400 ($15,000 – $3,600).

 

To calculate the property’s ROI:

  • Divide the annual return ($11,400) by the total investment amount, which is $137,500.

ROI = $11,400 ÷ $137,500 = 0.083 or 8.3%.

Your ROI stands at 8.3%.

 

The Importance of ROI for Real Estate

Understanding ROI (Return on Investment) is essential for real estate investments as it empowers informed decision-making. Prior to any purchase, it’s vital to estimate the costs, expenses, and potential rental income associated with the property. This paves the way for meaningful comparisons with similar properties.

Assessing potential returns is key to gauging the profitability of an investment. If it becomes apparent at any stage that costs and expenses might surpass the expected ROI, careful consideration is warranted. The choice may involve either holding onto the property with hopes of future profits or selling to mitigate potential losses.

Accounting for possible vacancies during periods when the property remains unrented and factoring in unexpected expenses related to rental property ownership, like repairs and maintenance costs, is paramount. These elements must be integrated into your calculations, as they can significantly influence the overall ROI.

Real estate investors also have the option of diversifying their portfolios and maintaining ROI through pooled investments, such as real estate investment trusts (REITs). These investment vehicles offer broader exposure to the real estate market and can yield a consistent return on investment.

Calculating ROI: The Bottom Line

ROI calculations for rental properties deviate from other investments due to variables like financing and cash payments. Generally, a smaller upfront cash payment with a larger mortgage loan balance can result in a higher ROI, while a larger upfront cash payment with less borrowing leads to a lower ROI. Financing can provide a short-term boost to ROI by reducing initial costs, although it decreases cash flow.

To gain a precise view of your investment portfolio, consistency in measuring ROI for multiple properties is crucial. For example, if you include a property’s equity in one property’s evaluation, you should do the same for other properties when calculating the ROI for your real estate portfolio. This comprehensive approach ensures a thorough understanding of your investment performance.

By leveraging the features of Landlord Studio, which encompass precise income and expense tracking, detailed real estate reporting and analytics, and maintenance management, we equip you with all the tools needed to optimize your rental property management and maximize your ROI.

 

 

More Property Blogs HERE: 

How to Reduce Tax on Rental Income

Challenges of Owning A Second Home

What insurance is needed for a buy-to-let property?

What is the difference between remortgage and refinance UK?

Buy Refurb Refinance Rent (BRRR) Explained

Section 24 Tax Guide for Airbnb Hosts

Can you make money investing in property?

Section 24 Effect on BTL Property

How do you calculate BRRRR?

{"email":"Email address invalid","url":"Website address invalid","required":"Required field missing"}
>