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Most people who invest in real estate do so to increase their wealth. Although their motivations may differ – some may want to invest for a life event, such as having a baby, and others may want to put money away for retirement – making money is usually the basis of all investments.
One type of investment that is considered better than the rest is real estate. People usually purchase real estate properties with the intent of making money through rental income or selling them for a profit in a brief time. No matter the intention, all real estate investors need to understand and be able to measure ROI. Below, we will discuss what ROI is, how to calculate it, and why it’s important to measure.
What is ROI?
No matter what type of investment you choose, if you want to be a successful investor, you must understand and be able to measure ROI. Knowing the ROI of an investment, such as a rental property, helps you to be a more informed investor. But what exactly is it?
The ROI, otherwise known as return on investment, measures how profitable an investment is. It can be used to compare several different investments, such as the profitability of bonds, savings accounts, stocks, or buy-to-let property.
How to Calculate Rental Property ROI
Calculating ROI on a rental property is much easier than you’d expect. If you want to calculate ROI, follow these steps:
- Calculate your annual rental income.
- Subtract your expenses – this includes management fees, mortgage payments, additional services, repairs, periods without a tenant, etc.
- Divide this figure by the amount of money you invested into the property.
- Multiply this figure by 100 to get the final percentage ROI figure.
What is a Good ROI for Landlords?
What one investor considers a reasonable ROI may not be considered so for another. A good ROI on a rental property varies by risk tolerance. The more risks you take, the higher ROI you might make. On the other hand, risk-averse investors may be happy to settle for a lower ROI in exchange for more security.
However, to make this kind of investment worthwhile, investors try to get an ROI that matches or exceeds the average returns on the primary stock market index. Historically, this is around 10%.
Costs That Can Reduce Your ROI
In order to realize your ROI in cash profits, you have to sell the rental property. Unfortunately, not all properties sell at their market value. When a property sells below its expected value, this reduces your expected ROI.
As well as this, several costs are associated with selling real estate, such as landscaping, painting, repairs, the cost of advertising the property, and any fees you have to pay to a real estate agent or broker. And, of course, the mortgage on the property needs to be considered.
Taxes to Expect When You Sell a Rental Property
All property owners in the US are required to pay property tax. This is a considerable sum of money that is used for things like local services and schools. However, thankfully, there are ways to reduce the amount of money investors pay. For example, they can use a RE Cost Seg.
Unfortunately, the same can’t be said when you sell an investment property. When you sell an investment property, you will have to pay a certain sum of money in tax. Any earnings you make over your adjusted cost basis is deemed a capital gain for tax purposes. The less time you’ve had this investment, the more money you will have to pay.
Although investing in property is considered one of the safest investments you can make, keeping a close eye on your ROI is essential. This will help you to determine whether or not the investment you have made was a good one.