Rental Property Calculator 2023
What You Should Know
- This rental property calculator can help you estimate your rental income and total profit on your rental home.
- Your rental income depends on your operating expenses as well as your financing expenses, which include your mortgage interest payments.
- This calculator can also help you compare rental properties based on financial metrics such as Cap Rate, IRR, and Cash-on-Cash.
- A rental property can be an attractive investment opportunity, but it is important to understand what rental income can be expected from the property.
How Do You Calculate Rental Income?
Different factors may affect rental income. The easiest way to estimate how much you can get out of your rental property is to calculate your income from the property and subtract your operating expenses from the property.
Operating expenses can include property tax, insurance, and maintenance expenses. Your rental property might not be occupied all the time, so an estimated vacancy rate may also take away from your estimated monthly rent income.
Income from the rent and operating expenses can only provide a rough estimate of your actual income. You may also need to account for financing costs to accurately estimate your net rental income.
How to Calculate Net Income for Rental Property?
To accurately estimate your net operating income for a rental property, you should subtract your operating expenses from rental income:
NOI = Rental Income - Operating Expenses
Rental income usually include the rent itself, but it can also include additional services tenants pay for. Operating expenses include all expenses that are required to keep the property running.
Rental Income
The main income of rental properties is the rent tenants pay to live there. This will be the main cash inflow for an investor. However, more income can be generated if you decide to sell your property in the future.
The monthly gross rental income you receive will depend on factors such as the rent you charge, additional services you provide, and the vacancy rate your property experiences.
- Monthly Rent: To choose how much rent to charge, you should consider the value of your property. For example, it is considered reasonable for the rent to be 0.8% to 1.5% of the purchase price of the rental property.
What Is the 1% Rule in Real Estate Investing
A rule of thumb is that a rental property should generate monthly rent equal to 1% of the home price. This amount of rent refers to the gross rental income. The net operating income is usually much lower because operating expenses take a large portion of the income.
For example, a property worth $300,000 should generate $3,000 per month in gross rental income according to this rule. It is important to note that this rule may not hold for more expensive areas where the average house price may reach $500,000 - $1,000,000.
- Other Income: Other income can be earned if you charge your tenants for additional services or amenities. For example, you could charge the tenants money for using the building’s laundry room, or for access to the swimming pool.
- Vacancy Rate: You may not have tenants all year round. You should account for the vacancy rate, which estimates how much your property will be empty. A good vacancy rate is around 2 to 4% in metropolitan areas.
Operating Expenses
Rental property usually incurs operating expenses that may take up a large portion of rental income. These costs are necessary to keep your rental property running. Operating expenses usually include property tax, insurance expenses, and maintenance expenses. Operating expenses have to be deducted from your rental gross income to find the net rental income a property generates. The following items are usually considered operating expenses:
- Property Taxes: It is typically the landlord’s responsibility to pay the property taxes on a rental property. These taxes will largely depend on the value of your property and the state that you live in.
- Homeowner's Insurance: This insurance provides dwelling coverage, personal property coverage, liability coverage, and coverage for other structures such as a detached garage. The landlord will have to pay insurance premiums based on how big the liability limit is, what incidents it covers, and the value of the property.
- Landlord Insurance: While landlord insurance is not legally required, you might not be able to get regular home insurance if you are renting your property to others without landlord insurance. Landlord insurance usually provides liability coverage to your rental property. If a tenant is hurt, then your liability coverage can cover expenses.
- Property Management Fee: Property managers can help you manage your property and resolve tenant conflicts. Property managers usually charge 8% - 12% of the gross rental income.
- Repairs Expense: Repairs and replacements around the house usually cost around 1% of the home purchase price annually. The landlord is usually responsible for making the repairs needed on a property.
- Utility Expenses: Utilities can be paid by the tenants or by the landlord depending on the agreements they have. You may choose to charge the tenant a flat fee for utilities and include it in the rent, or the tenant can pay for the utilities that they use every month.
Financing Costs
Most people usually cannot afford to pay the whole purchase price of a rental property in cash, so they may choose to get a loan for the investment property. If this is the case, you will have to pay interest on your loan. How much you put down, your interest rate, and your loan term will determine the financing costs that you will have to make in a given month.
The financing costs will be deducted from your total income to find the net income the property generates. The higher the financing costs, the lower the net income. While financing the rental property through a mortgage lets you have more flexibility with your money at first, it also means that you will use most of your rental income to pay off your mortgage and other expenses.
The financing costs mainly consist of the monthly mortgage payments you will have to make, which are made up of the principal and the interest payments.
- Down Payment: The down payment affects your monthly mortgage payments and the upfront cost of investment. A higher down payment will result in a lower monthly payment, but will require a larger upfront cost.
- Interest Rate: A lower interest rate will result in a lower mortgage payment, less financing costs, and ultimately a higher return on your investment.
- Loan Term: A shorter loan term typically results in a higher monthly payment. While a longer-term loan with its lower monthly payment may result in a higher annual return for your investment property, you will end up paying more in interest throughout the life of your loan. This means that the overall total return on your investment, in the end, will be lower.
Profitability Metrics of a Rental Property
There are four common metrics used to estimate how profitable an investment property is: Return on Investment (ROI), Capitalization Rate (Cap Rate), Cash-on-Cash (CoC), and Internal Rate of Return (IRR). ROI, Cap Rate and CoC are similar metrics in their approach to calculate the return. ROI and Cap Rate compare net income a property generates over a specific period of time to either the value of a property or value of an investment. Return on investment compares net income to the cost of an investment or the amount an investor paid for a property. On the other hand, capitalization rate compares net income to the market price of the property. This section looks closely at both of these metrics and compares them between each other. Cash-on-Cash ratio compares the cash inflows relative to the cost of an investment. CoC ratio is similar to ROI, but it does not include the principal payment for the mortgage if a property is financed.
The following list provides clear definitions of what each metric in this calculator means.
- Return on Investment (ROI)
ROI calculates the average of how much income a rental property generates compared to the amount invested. A part of income from a rental property may go to building equity on the property.
- Cash-on-Cash (CoC)
CoC calculates how much cash a rental property generates compared to how much cash has been invested. If a property is financed, then part of the income a property generates goes towards building equity. Since the building equity part of generated income is not returned as cash, it is not included in the calculation.
- Capitalization Rate (Cap Rate)
Capitalization rate looks at how much income a rental property generates compared to the house price. Capitalization rate does not take into account financing of a property. It assumes that the property is fully financed.
- Internal Rate of Return (IRR)
IRR is widely used in finance to estimate the profitability of a project. It is a discount rate that makes the net present value of all future cash flows equal to zero. In this case, IRR accounts for a gain that comes with a sale of a house. This means that it estimates the return given that a property will be sold at a certain point in the future.
Internal rate of return also provides an insight about the profitability of a rental property, but it has a different approach compared to the other three metrics. IRR focuses on a net present value (NPV) of a rental property. A net present value is a sum of future cash flows discounted to the present day. IRR is found by looking for a discount rate that makes NPV equal to 0.
How to Calculate ROI on a Rental Property
Return on investment (ROI) is a ratio between the return (profit) from an investment over the cost of the investment. This means that ROI shows how much you will make from your rental property as a percentage of the total cost per year, and can be used to see if your rental property is worth the investment.
There are different ways to calculate ROI for different investment purposes. Some people may prefer to calculate ROI on the whole investment while others may choose to calculate the gain based on the price per square foot. Return on investment for rental properties is usually calculated using a net income and the cash paid to acquire the property, which is called an investment cost of the property.
A positive ROI figure means that you are making money, while a negative ROI will mean that you are losing money. Likewise, a higher ROI means that you are making more money per dollar invested, suggesting that your investment is producing fruitful returns. However, unreasonably high ROIs may prompt a second look.
If a property is bought with cash only, then the investment cost is equal to the price of the property plus closing costs and any repairs made to the property. On the other hand, if a property is financed with a mortgage, then the investment cost is equal to the down payment plus closing costs and any repairs made to the property.
To calculate the ROI of a rental property, you would first need to calculate your rental property’s net income and operating expenses. You may also need to include financing expenses such as interest expenses if you financed your rental property with a mortgage.
A positive ROI figure means that you are making money, while a negative ROI will mean that you are losing money. Likewise, a higher ROI means that you are making more money per dollar invested, suggesting that your investment is producing fruitful returns. However, unreasonably high ROIs may prompt a second look.
Borrowing to invest means that your ROI will be higher as your initial upfront cost is lower than paying in full with cash, but it also means that you are susceptible to mortgage rates that may change over time. High mortgage rates may eat away a big part of your return on investment. Borrowing also creates a risk of default in the event you cannot pay for a mortgage. If you cannot pay for a mortgage, your property may be put into a pre-foreclosure, and you would have to be forced to sell it at a loss.
How to Calculate Cap Rate on a Rental Property
The capitalization rate, also known as the cap rate, measures your property’s annual return relative to the value of the property. In other words, it measures the return on investment (ROI) if the property was purchased fully with cash. This means that return on investment and capitalization rate are the same for properties that are purchased with cash. Capitalization rate can be used to find out how long it will take for your investment to be paid back.
Using capitalization rate, you can find how long it will take for your investment to pay for itself. After finding an annual capitalization rate, you can use the following formula to calculate how many years it will take for your property to pay for itself.
How to Calculate Cash-on-Cash Ratio for a Rental Property
Cash-on-Cash ratio calculates how much cash a rental property generates compared to how much cash has been paid for it. In other words, it is a ratio of cash flow to investment cost of a rental property.
This metric is very similar to ROI. The only difference between them is that ROI looks at net income while CoC looks at cash flow. When it comes to rental properties, the difference between net income and cash flow is the principal mortgage payment. Principal mortgage payments are not subtracted from net income because it is not an expense even though it does require a cash payment. On the other hand, cash flow does not account for principal mortgage payments because even though it is part of income, it does not come in the form of cash. The following formulas are used to calculate the cash-on-cash ratio.
Generally speaking, cash-on-cash tend to be lower than ROI
How to Calculate IRR on a Rental Property
Before jumping into the discussion about IRR, it is important to understand what net present value (NPV) is, and how it changes when cash flows and discount rates change. Calculating present value involves taking the sum of all future cash flows of a rental property where each cash flow is discounted by a chosen discount rate.
NPV can be positive or negative depending on the value of future cash flows (Ci) and discount rate (r). For example, IRR is a discount rate that makes the net present value of rental property cash flows equal to 0. This rate of return may be insightful when a rental property generates inconsistent returns year over year. If the returns are inconsistent, then the variables like ROI and CoC may not be as insightful while IRR may provide a more accurate measure of return.
Example - IRR in Real Estate
You purchase a rental property paying $150,000 in cash. You charge a rent of $1,000 per month and incur operating expenses of $300 every month. In 5 years, you sell the rental property for $180,000.
Yearly Cash Flow = 12 * (Monthly Rent - Operating Expenses) = 12 * ($1,000 - $300) = $8,400
Initial Investment = $150,000
Cash Inflow Year 1 - 4 = Net Income = $8,400
Cash Flow Year 5 = Cash Inflow from Sale + Net Income = $180,000 + $8,400= $188,400
A discount rate that makes NPV equal to 0 is 8.945%. This discount rate is the internal rate of return (IRR) for the property you purchased.
Cap Rate Versus ROI
Cap rate is based on the property being paid in full in cash. If your rental property was paid in cash, the cap rate of your rental property will be the same as your return on investment figure. If your rental property is financed, then you would use ROI instead of the cap rate.
The difference in Cap Rate and ROI stands only in the means you use to finance the purchase, which decides whether you will have to spend money on financing costs throughout the year and the cost of your investment. If you purchase the property using only cash, there are no financing costs which makes you have a higher net income. However, the cost of your investment is also larger since you will have to finance the purchase with your own money. In this case, we use Cap Rate.
| Cap Rate | ROI | CoC | |
|---|---|---|---|
| Used when you finance the property through: | Cash-only | Loan | Loan |
| Financing Costs | $0 | 12 × Monthly Loan Payment | 12 × Monthly Mortgage Payments |
| Cost of Investment | Purchase Price + Closing Costs + Repairs | Down Payment + Closing Costs + Repairs | Down Payment + Closing Costs + Repairs |
Example - Cap Rate vs ROI
Tom and Linda are both rental property investors looking for their next project. Tom has saved up a lot of money and plans to purchase a rental property using cash only. Linda, on the other hand, will need to use a loan to finance the investment. Tom argues that since he won’t have to pay any financing costs, he will have a bigger return on the investment. However, Linda thinks the opposite. Since the initial investment will cost her less, she thinks she will earn a higher return on it. Who is right?
| Home Purchase Information | Financing Information | Rental Information |
|---|---|---|
| Purchase Price = $350,000 | Down Payment = 20% | Rental Income = $3,500/month |
| Closing Costs = $5,000 | Loan Term = 15-Years | Operating expenses = $8,000 |
| Interest Rate = 3% |
Since Tom uses cash only, we will use the Cap Rate to measure his return and ROI to measure Linda’s return.
| Cap Rate - Tom | ROI - Linda | |
|---|---|---|
| Total Income | $3,500 * 12 = $42,000 | $3,500 * 12 = $42,000 |
| Operating Costs | $8,000 | $8,000 |
| Financing Costs | N/A | $1,180 * 12 = $14,160 |
| Net Income | $34,000 | $19,840 |
| Purchase Price | $350,000 | $350,000 |
| ⇒ Down Payment | N/A | $70,000 |
| Closing Costs | N/A | $5,000 |
| Cost of Investment | $350,000 | $70,000 + $5,000 = $75,000 |
| Return | ($34,000/$350,000) * 100 = 9.714% | ($19,840/$75,000) * 100 = 25.453% |
In this case Linda has a higher return on investment than Tom does because she paid less upfront for the property. Generally, return on investment should yield a higher return than a capitalization rate whenever a property is financed with a mortgage.
Example - CoC vs ROI
Now suppose that Linda is a recent graduate, and she does not have that much money saved up. She likes the return on investment she gets, but she also wants to know how much cash she will be getting to supplement her current income. She wants to calculate the cash return on the cash she invested and compare it to the return on investment. In her case, the main difference between the income she receives and cash she receives from the property comes from principal payments she makes on the property. When it comes to her income, she includes principal payments in her income because she builds equity for her house. On the other hand, she does not include principal payments in her cash flow calculations because she does not receive the principal amount in cash when building equity.
| Home Purchase Information | Financing Information | Rental Information |
|---|---|---|
| Purchase Price = $350,000 | Down Payment = 20% | Rental Income = $3,500/month |
| Closing Costs = $5,000 | Loan Term = 15-Years | Operating expenses = $8,000 |
| Interest Rate = 3% |
| CoC | ROI | |
|---|---|---|
| Total Income | $3,500 × 12 = $42,000 | $3,500 × 12 = $42,000 |
| Operating Costs | $8,000 | $8,000 |
| Financing Costs | $1,934 × 12 = $23,208 | $700 × 12 = $8,400 |
| Net Income | $10,792 | $25,600 |
| Purchase Price | $350,000 | $350,000 |
| ⇒Down Payment | $70,000 | $70,000 |
| Closing Costs | $5,000 | $5,000 |
| Cost of Investment | $70,000 + $5,000 = $75,000 | $70,000 + $5,000 = $75,000 |
| Return | ($10,792/$75,000) × 100 = 14.39% | ($25,600/$75,000) × 100 = 34.13% |
After doing all necessary calculations, Linda comes to a conclusion that her return on investment is much higher than her cash-on-cash. This means that even though her property generates a high return, most of the generated income goes to paying off her mortgage. Even though her cash-on-cash is lower than return on investment, she still gets to receive a good portion of cash every month from the property.
How is Capital Gains Calculated on Sale of Rental Property
To calculate capital gains from your rental property sale, you will need to first calculate the cost basis of the property and the net proceeds from the sale of the property.
The cost basis is the cost of any improvements that you made to your rental property, such as remodels or a new roof, in addition to the original amount you paid for your rental property along with purchasing costs, such as closing costs and appraisal fees.
Net proceeds is your rental property sale price, with costs, subtracted, such as real estate agent commissions, staging, and lawyer fees.
To find the capital gain, you would subtract the total cost basis from your net proceeds. A positive capital gain would mean that you made money, while a negative capital gain would be a loss. Capital gains tax may apply. To avoid capital gains tax, you may consider selling your property using a 1031 exchange that allows you to exchange one property for another without paying capital gains tax.
Why Invest in Rental Properties?
Rental properties are an attractive investment opportunity for a number of reasons:
- Passive Income Source
Even though there are a lot of responsibilities to being a landlord, you still have to put in less time and effort than you would in a regular job. Moreover, by hiring a property management firm, there is even less for you to do. This makes rental properties a great investment opportunity that constantly generates income.
- Tax Benefits
When you own a rental property, there are a number of expenses that you can write off to lower your tax obligation when you file your income tax return. These expenses include:
Interest - if you purchase your investment property through a loan, you get to deduct the mortgage interest you have paid for during the year in your yearly income tax return.
Depreciation - Rental property owners can depreciate their property by 3.636% yearly over 27.5 years. They can write off this depreciation as an expense when filing their income tax return.
Repairs - Any repairs you make on the rental property can be deducted from the tax return on the year during which you made the repairs.
Insurance - You can deduct insurance premiums that are related to your rental property and to you as a landlord. For example, you can deduct landlords insurance premiums from your income tax returns.
- Long-term Appreciation
Just like any other property, your rental property will typically appreciate in value as the years go by. This will be a major asset for you as you can choose when to sell it to earn a large return.
- Inflation Effect
Inflation typically lowers the value of assets. However, investing in real estate can be safer as the value of the properties rises and lowers with inflation. Therefore purchasing a rental property can be a good way for your wealth not to be largely affected by inflation.
- Greater Diversification of assets
Diversifying assets is a good strategy to lower the total risk of your investments. Therefore, if you have most of your assets stored in other markets, investing in real estate and diversifying your portfolio might help offset that risk.