If you plan to rent out your home or buy a new rental property, you will probably spend some time considering how much profit you should make on your rental. In other words, is it a good deal to acquire a rental property or rent an existing one, or not? Understanding the rental investment profitability is no straight-forward business, so we would like to walk you through several indicators you should take into account before making any decision.
Monthly cash flow
Let us start off with the monthly cash flow, – the amount of money the rental property generates after all expenses are deducted (also known as the net operating income, or NOI).
Like any business, your rental property generates monthly income and expenses. Roughly, there are 5 types of expenses, – management, maintenance, vacancy, taxes, and insurance, – which all depend on the condition of the property. For instance, your maintenance costs will be higher on an older property. DIY landlords out there may be wondering why we understand management as a cost. Truth is, even if you are a DIY landlord, management is still a cost: it measures the time you spend managing your property.
All in all, your monthly expenses will amount on average to about 40% of your monthly gross revenue, and in real estate terms, these are your operational expenses. To the costs mentioned above, you should be factoring in any debt service on the property. For those landlords who depend on rental income to pay mortgages, do not let the value of the mortgage dictate the rental rate you ask for! It is tempting to think that your rental income should at least cover your mortgage. Unfortunately, only the rental market dictates what you can ask for, and rental rates can only be established in comparison with similar properties on the market. So make an effort to set aside your debt service and analyze the real rental value of your property on the market.
That being said, what can you expect in terms of monthly cash flow? If you do not pay a mortgage, then you can rely on about 60% of your monthly gross revenue. On a property that has a mortgage, your monthly cash flow is much lower, at about $100 to $300.
Typically, a profitable property generates positive cash flow, but if yours generates more costs than revenue, do not immediately despair. Many experienced investors decide to buy rental properties they know will generate a negative cash flow because other reasons make them profitable in the long run, such as property appreciation, paying down the amortization of the loan, deducting their losses and depreciation from their taxes, or a long-term increase in the market rent in that area.
The 1 percent rule
Another indicator that can help you understand what is a good rate of return on your rental property is