Rental Income ROI

[hopeisnotaplan]

What would you consider an acceptable ROI % for a rental property? For example, say I have a potential rental property worth $150K (paid off - no mortgage) and that's about what I have in it, and the rental income is $1250 per month or $15k annually. If I clear about $12k after taxes/misc expenses that's only an 8% annual return on 150k.

Would that be on the low end of your comfort zone or is that a pretty decent situation in your opinion?

 

[jkern]

I think 8% is excellent. But I'm from CA where the ROI on RE is much lower than other parts of the country. There are many properties in the SF Bay Area that would be lower than 5%.

 

[calmloki]

Anyone who wants to guarantee me an 8% return forever I'm in for a pile. For a single house in my area $1250/mo for a $150k house is pretty normal.I strongly question you clearing $12K on $15k rent though. Taxes, insurance, maintenance, reserves for the roof or furnace or whatever, vacancy... think more like clearing $7-8K over the long haul. 5.5-6% + appreciation feels more likely. But that is in my area - some do much better. or not.

 

[Rickt]

I would look for a minimum CAP rate of 8%. Anything less than that you may as well invest in a REIT and save yourself management hassles. Just my opinion.

 

[Dash man]

I think 8% is fine if you don't have a mortgage. If it were leveraged I'd want 15% or more to cover the vacancy risk.


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[Fishingmn]

As others have said, I'd buy more if I could get 8%. That was always my minimum number and over time that has gone up with rent increases to where I'm now at 9.7% with conservative expense estimates.

Which brings me to the issue of your estimates. You are estimating only $3k/year in expenses? That seems really low to me.

I always figure in 3-5% for vacancy
I figure in $800/year for repairs/maintenance per property and these are townhouses where the HOA covers outside maintenance. This week I put in a $2k furnace and an $800 water softener at different units.
I figure in taxes
I figure in a $150/year landlord insurance policy for $1M in liability coverage
I figure in a $100/year budget for possible evictions - never had one luckily
Many cities have a rental license that I have to pay for as well - around $50/year
I also have HOA dues which cover things like lawncare/snow, garbage, water, insurance and outside maintenance.

Your numbers seem low in other words.

As an example, I have one unit that rents for more than yours at $1,290/mo and I figure that I only clear about $9,800/year.

 

[Senator]

My properties, based on the tax values and projected expenses, return between 9% and 15%. I have 4-plexes for the most part, and use a 10% of rents for maintenance, 7% for management, 5% for vacancy. 2 out of 5 of these buildings are paid off and still return these numbers. With these projections, and the actual hard expenses, my expense ratio is 45.52%.

I do most of my own management and maintenance, so I am able to get an even higher return than my projections. As the properties get less doors, expenses go up. My duplexes, which are paid off, bring in 6% - 9%. Overall, between all properties, my ROI is at least 9.17%.

Your 8% is not bad, but the expenses you list are not a good estimate. Unless you bought a major dump and fixed it up, It is near impossible to make money on a single family home. If you count future appreciation, tax benefits, principle paid off each month, etc., it may be closer to your numbers.

I am not saying to sell the rental, but your actual return is not even close to 8%. My minimum is a 12% cash on cash return, or a 8% cap rate. I am generally not buying anymore, but quality of the neighborhood matters too.

 

[Sittinginthesun]

My properties, based on the tax values and projected expenses, return between 9% and 15%. I have 4-plexes for the most part, and use a 10% of rents for maintenance, 7% for management, 5% for vacancy. 2 out of 5 of these buildings are paid off and still return these numbers. With these projections, and the actual hard expenses, my expense ratio is 45.52%.

I do most of my own management and maintenance, so I am able to get an even higher return than my projections. As the properties get less doors, expenses go up. My duplexes, which are paid off, bring in 6% - 9%. Overall, between all properties, my ROI is at least 9.17%.

Your 8% is not bad, but the expenses you list are not a good estimate. Unless you bought a major dump and fixed it up, It is near impossible to make money on a single family home. If you count future appreciation, tax benefits, principle paid off each month, etc., it may be closer to your numbers.

I am not saying to sell the rental, but your actual return is not even close to 8%. My minimum is a 12% cash on cash return, or a 8% cap rate. I am generally not buying anymore, but quality of the neighborhood matters too.

My rental property cost $390k in 2012. I have a mortgage for $195k on it (was originally $300k but I have been paying it down even though its a good deduction against income). Rental income (short term vacation rental) was $60,915 in 2014 and $72,950 this year. Costs are about $40,000 per year including mortgage interest, taxes, insurance, maintenance, utilities, HOA fees, upgrades to furniture, etc. I also use the place 35-40 nights a year for vacations and love it there.

Its also now worth somewhere around $460k

How would you rate this place as an investment? Its my first real estate rental. Short term rental has been headache free and only a few hours a month in time committed to managing it.

 

[emi guy]

I would be careful advertising your 40 day vacation usage if you deduct expenses as an investment property. I believe you might be limited to just a few weeks personal use per year.

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[Sittinginthesun]

I would be careful advertising your 40 day vacation usage if you deduct expenses as an investment property. I believe you might be limited to just a few weeks personal use per year.

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We are 100% honest about our personal use and our accountant only deducts a percentage of costs related to days of rental use. I'm a straight shooter when it comes to taxes.

 

[tryan]

Sittinginthesun -

Our numbers are similar except I can only gross ~49k/yr. I have "dual" seasons - skiing and lake front.

Curious how you hit 70k: Are you located such that renting year-round is possible? Where/how do do advertise?

I am on about a dozen websites (Homeaway, vrbo, airbnb, glamping hub .....) but I have come to ~50k as the "ceiling".

 

[Senator]

How would you rate this place as an investment? Its my first real estate rental. Short term rental has been headache free and only a few hours a month in time committed to managing it.

It appears you manage it yourself, do you account for a 10% management fee anyway? If not, you are managing for free. It should be used when analyzing a property.

The HOA fees cover much of the maintenance, such as a roof. What about HVAC, Water heater, kitchen cabinets, etc. Do you keep an amount to the side for these major upcoming periodic expenses?

You take in ~$33k on a $390K investment. That is ~8%. The appreciation, depreciation, vacation days used, etc. do not count in my book. They are hard to spend. They are just bonuses.

 

[tryan]

Forgot to mention we can "work" as many days/nights as we want. "personel use" is limited to 2 weeks if we claim 100% rental.

It's a nice place to "work" ...

 

[Sittinginthesun]

It appears you manage it yourself, do you account for a 10% management fee anyway? If not, you are managing for free. It should be used when analyzing a property.

The HOA fees cover much of the maintenance, such as a roof. What about HVAC, Water heater, kitchen cabinets, etc. Do you keep an amount to the side for these major upcoming periodic expenses?

You take in ~$33k on a $390K investment. That is ~8%. The appreciation, depreciation, vacation days used, etc. do not count in my book. They are hard to spend. They are just bonuses.

Property manager fees are cheap and included in the $40k cost as are upgrades to interior which we are constantly doing to keep the place beautiful. Well over 50% of our renters are repeat guest this year.

HOA fees cover nothing but community costs like security, maintenance, etc. I spent little of the income and a major expense like new HVAC or roof wouldn't be an issue.

Why is it 8% when I don't have $390k tied up in the property? Just trying to understand that logic. I initially had about $100k into it, more now with mortgage payments and lump payments against the principle. Could argue its a 33% return on initial investment, no?

Thanks for your feedback.

 

[Sittinginthesun]

Sittinginthesun -

Our numbers are similar except I can only gross ~49k/yr. I have "dual" seasons - skiing and lake front.

Curious how you hit 70k: Are you located such that renting year-round is possible? Where/how do do advertise?

I am on about a dozen websites (Homeaway, vrbo, airbnb, glamping hub .....) but I have come to ~50k as the "ceiling".

Tryan we have renters year round and two high seasons (winter and summer). I rent the winter out to a retired couple (two months) and another retired couple (one month). Summer is sought after by Europeans looking for a hot getaway.

VRBO is our only advertisement but its a good one. Had professional photos done and its a really nice place. We also have a lot of great reviews and not a single one less than 5 stars.

 

[nun]

What would you consider an acceptable ROI % for a rental property? For example, say I have a potential rental property worth $150K (paid off - no mortgage) and that's about what I have in it, and the rental income is $1250 per month or $15k annually. If I clear about $12k after taxes/misc expenses that's only an 8% annual return on 150k.

Would that be on the low end of your comfort zone or is that a pretty decent situation in your opinion?

Are you including depreciation. The rental income you report on your 1040 is a bit different from the net income you get in your hand each year.

FYI I bought a $100k rental apartment in 1997. I get $14.5k a year in rent from it, but after expenses, sewer, insurance, taxes, depreciation I declare between $7k and $8k in income on the 1040. I'm happy with that, particularly as it's worth $250k now. I could put the rent up, but I like my tenant and she's been there for 10 years.....maybe next year. But I just put in a new natural gas furnace and that cost me $4.5k....well more to depreciate I suppose.

 

[phil1ben]

During the recession 2009-2010 we bought 3 single family homes in vacation destination areas. They are located within 10 minutes from our primary residence (in a destination area) and 10 minutes from our beach house. Two of them only rent for 11 weeks per year during the beach weeks and the third one rents the entire year. My wife manages the properties and we paid cash for all with no mortgage. The two beach properties lease through local realtors (10% fee - that is the procedure in this area) and the other we rent exclusively through VRBO/Homeaway.

We have been averaging 6-7%. Your expenses seem very low but you know the property. In addition to the rental income we also thought we were buying at a good time and might realize some appreciation. Fortunately, as of this time, that has been the case. Who knows how the real estate market will do in the future.

 

[Senator]

Why is it 8% when I don't have $390k tied up in the property? Just trying to understand that logic. I initially had about $100k into it, more now with mortgage payments and lump payments against the principle. Could argue its a 33% return on initial investment, no?

You are correct. It's $33K/Property Equity. If you have $100K into it, it's 33%.

Typically, the less you have invested, the better the ROI. In the old days of 3% down, you could make a killing. Put down $3K, make $3K, 100% return. But the risk was too great, especially for the banks.

 

[Ed_The_Gypsy]

This is a very useful and timely thread for me.

We are in a position to buy our DD's condo (half of a duplex in Tucson) from her outright for as little as $75k. We would have 100% equity. It appears to be worth about $110k when in good shape. It is in a gated community on the west side, which seems to be well-sited. We helped her pick it out.

I am eye-balling about $5k to $10k to fix it properly. Our choices are
a) fix it and sell it (May seems to be the best month to sell in Tucson),
b) fix it and rent it out (we would hire a quality property management company since we do not live there; it appears that it should rent for at least $950/mo), or
c) fix it and use in as a winter getaway (not very practical, I think, but if we choose to sell next May, we could have this winter).

All things considered, b) appears to be an attractive choice. We know the condition (it needs work) and have some idea of the costs of fixes, upkeep and management (thanks, Senator!).

We would appreciate any comments on this idea.

Ed

 

[ArkTinkerer]

You are correct. It's $33K/Property Equity. If you have $100K into it, it's 33%.

Typically, the less you have invested, the better the ROI. In the old days of 3% down, you could make a killing. Put down $3K, make $3K, 100% return. But the risk was too great, especially for the banks.

Brings up an interesting question--at what point do you start figuring the ROI based upon a reasonable selling price of the property? Obviously, given a good market, it would make sense to either sell or refinance when the loan/value ratio gets low and buy another property or two.

My wife would not be happy with me buying another property unless we hire out more of the management of the units we have. And we just might do that soon.

 

[Fishingmn]

Brings up an interesting question--at what point do you start figuring the ROI based upon a reasonable selling price of the property? Obviously, given a good market, it would make sense to either sell or refinance when the loan/value ratio gets low and buy another property or two.

At least in my market the "good market" means I can't find anything that matches the 8%+ returns that were easy 3-4 years ago. That's the challenge here - finding 1 or more properties to convert it into.

 

[pb4uski]

I just went through this in renegotiating a 10 year lease of my mother's commercial property (I manage it for her... for free). Our 30+ year single tenant asked us to make numerous improvements which will amount to ~20% of the value of the property.

I project our after-tax ROI to be ~14% in the first year of the renewal. After-tax profit/beginning of year value of the property after our improvements. The lease has an annual escalation so the ROI, assuming the same denominator will increase to 16% over the ten year term. Since we own the building, all of these are unleveraged returns.

 

[Senator]

Brings up an interesting question--at what point do you start figuring the ROI based upon a reasonable selling price of the property?

I think you have to look at the final net in real estate and compare that to the return you are getting. That is after commissions, depreciation recapture, capital gains, etc.

And find another investment with a better return and the same or lower risk.

I would have a hard time finding one for myself, not outside of a rental.

 

[retiredinnyc]

If you are already a landlord than that's a fine return in my book. However, if your not rent the movie pacific heights. If you get a bad tenant you will have ZERO return. I had an investment property real nightmare. Husband left the wife , she stopped paying , took Eleven months to throw her out. I didn't both to try to get a judgement fit it . It was good riddance to bad garbage. If I want real estate I'll by a reit, besides my home reprints about 20% of my net wealth so that's enough exposure for me

 

[FI by 2024]

I think you have to look at the final net in real estate and compare that to the return you are getting. That is after commissions, depreciation recapture, capital gains, etc

I'm trying to figure this out mathematically (not trying to hijack, but if we can get a formula I think it would help the OP).

Is the formula I've laid out below how you determine ROI? To keep it simple, I won't factor in depreciation. Depreciation would help, so it should be slightly better than the end result of this equation.


(Sale price)
- (closing costs)
- (mortgage payoff if needed)
- (capital gains)
- (money put in over time (down payment, mortgage, maintenance, management, taxes, etc))
+ (rents paid)
------------
= total return

Then
(Total return) / (money put in) = ROI over time

And
(ROI over time) / (# of years since purchase) = average annual ROI


So, for example: investor purchases a house in Jan 2010 for $200K and sells in Dec 2015 for $300K. 20% down payment. Monthly PITI averages $1200 over the course of the loan. House is rented for $1700/mo and management is $150/mo. Average maintenance & vacancy is $3000/yr.


So:
$300,000 (sale price)
- $18,000 (closing costs)
- $143,000 (mortgage payoff)
- $15,000 (capital gains)
- $136,000 (money put in over time (down payment, mortgage, maintenance, management, taxes, etc))
+ $102,000 (rents paid)
------------
= $90,000 (total return)

Then
$90,000 / $136,000 = .66 or 66%
(Total return) / (money put in) = (ROI over time)

And
.66 / 5 = .13 or 13% avg ROI
(ROI over time) / (# of years since purchase) = average annual ROI


Is that a good way to determine ROI? Other than depreciation, am I leaving anything out?


And before anybody questions a 50% appreciation in 5 years, I'll point out that based on where I live and the years I used this is not only doable but conservative. YMMV.


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