Rental properties are very popular among people looking to build wealth. Part of the attraction is the ability to see and touch your investment. You also experience the joy of cash flow on a monthly basis from your tenants and the appreciation of your property’s value over time.
How do I calculate the return on my investment in a rental property?
This is where you need a little accounting knowledge to get to the correct result. Using two condominiums from the same complex in Branford, CT where one is for rent and the other is for sale, let’s run some numbers.
What numbers should you include?
From the condo that is for sale (plus other recent transaction from Zillow), we can get a purchase price, HOA fees and real estate taxes. From the condo that is for rent, we can calculate annual income. Using a 70% loan-to-value ratio and a 5% interest rate, we can compute an interest expense and the equity investment in the property.
Now the tricky part. You do NOT want to include capitalized expenses, such as a new roof or furnace, but you DO want to deduct depreciation and non-capitalized maintenance expenses, such as snow removal. Even though a new roof will decrease cash flow it is not a good estimate of the annual capital expenses associated with owning a rental property. Depreciation is the best estimate; it exists in accounting for exactly this purpose.
Below is a calculator that you can use to model other real estate rental scenarios.