Calculating your return on Investment (ROI) is an essential part of deciding whether a rental property is a smart purchase. Simply stated, ROI refers to the percentage of invested money that is recuperated as profit, after deduction of associated costs. How to Calculate Real Estate Return on Investment
As a formula, ROI looks like this:
ROI = (Gain from investment – Cost of Investment) / Cost of Investment
To find the ROI on any prospective investment, you will need to find or estimate several variables including historic rental prices, vacancy rates, maintenance costs, and closing costs.
How do you calculate return on investment for a rental property?
The best mortgage conditions for R.O.I are with a downpayment of 20-25% (thus avoiding mortgage insurance costs) over a 25 year amortization.
Let’s take as a case scenario the typical purchase of a $250,000 (2 bedroom) condominium in St Henri.
To calculate the ROI over 5 years:
- Downpayment of 20%: $50,000
- Total Acquisition costs = (Downpayment + Closing costs and fees) = $55,000
- Mortgage amount: $200,000*
- *Interest rate of: 2.29% (current lowest)
- Mortgage payments: $875/ month
- Property Insurance: $50/month
- Municipal taxes: $166/month School taxes are $40/month
- Condo fees: 100/month.*
- *based off the average taxes for $250,000 condos in St Henri
Total carrying costs: $1231/month
A semi furnished 2 bedroom condo in St Henri can be rented out for an average of 1300/month.
Net profit = rental income – carrying costs.
In this case, this condo brings in a profit of $69 / month.
The net income after all expenses will be positioned between break even and positive cash flow.
Rental net income after carrying costs over 5 yrs = ($69 x 60 months) = $4,140
Now to consider the additional equity gained through appreciation over the years:
A conservative average of appreciation rate in Montreal is 2% per year.
Value appreciation (assuming 2% on base price p.a non-compounding) = ($5000 x 5) = $25,000
Over 5 years the market value of a $250,000 property will increase to $275,000.
After 5 years, the mortgage balance left to pay will be: $180,212
Mortgage appreciation = initial mortgage – current mortgage = (200000-180,212) = $19,788
Total Gains = Rental net income + value appreciation + mortgage appreciation
Total Gains = $48,928 (total gains p.a = $8785.6)
ROI= Total gains / capital investment * 100
ROI = (48,928/55,500)*100
ROI = 88.96% over 5 yrs
ROI per year = 17.7%
To secure a high ROI investment, the different points to look out for are:
a) Low asking prices
b) Favourable mortgage terms (high downpayment and low interest rates, if possible)
c) Low condo fees and other carrying costs
d) Properties in locations where the rental value is high and vacancy rate is low
e) Locations where the appreciation rate is high or growing