So what is a good return on investment in real estate based on the capitalisation rate formula? Most real estate experts suggest that a capitalisation rate higher than 4s is optimal. However, as mentioned above, the return on investment will vary depending on location, property type, etc. Therefore, when comparing the capitalisation rates of various rental properties, make sure that they are in the same market and are similar. Comparing the capitalisation rate of a rental property with the average capitalisation rate of similar properties in the area will show you whether it is a good deal or not.
Generally, the average capitalisation rate of the area you are considering should be the minimum target when buying a rental property. Using the cash on cash ratio calculation, a good rate of return is 8-12%. Some investors will not even consider a property unless the calculation predicts at least a 20% rate of return. Again, this depends on you as an investor, and what your metric is for a good rate of return.
Whether the 6s a good rate of return on your investment is for you to decide. If you can find higher quality tenants in a nicer neighbourhood, then the 6s could be a great return. If you get the 6s or an unstable neighbourhood with a lot of risks, then this yield might not be worth it. Owning rental property can be a good way to generate income and build wealth over the long term.
But the truth is that not all rentals offer the same return on investment or ROI. As more and more people work from home and move to cities where the cost of living is lower, some of the highest returns on investment in single-family rental properties are found in smaller cities and in the suburbs of larger urban areas. In many real estate markets today, it is not always easy to find a rental property with a solid cash flow. Investors can also use Roofstock Cloudhouse's rental calculator to receive a forecast of the potential profitability of any single-family home in the United States.
The same factors apply to mortgages for rental properties, but the borrower will likely have to meet stricter credit score and DTI thresholds and a higher minimum down payment. If you can find a way to get a lot of tax credits, you can amend your returns for the last three years and the IRS will put a fat cheque in your pocket. The capitalisation rate is not the most accurate way to analyse a short-term rental investment, since the value of a short-term rental is based on comparable closed-end residential properties in the area, rather than on the income from the property. Pandemic or not, the fundamental things to look for when looking to buy a rental property remain more or less the same.
When deciding "what is a good rate of return on investment" keep in mind that return on investment is also a measure of risk. Factors such as rental income, occupancy levels, operating expenses, property taxes, mortgage rates, the location of the property and even the type of rental property being purchased have a significant impact on how good the ROI of a rental property is. Today, there are dozens of single-family rental homes for sale in the Roofstock Market with ROIs of 7.5% or more. Of course, experienced real estate investors understand that the ROI of a rental property can vary from one real estate market to another, and even within different neighbourhoods in the same city.
The type of rental property and the basic laws of supply and demand also have a significant impact on the ROI of a rental property. In the next section, we will discuss how the same rental property can have two dramatically different ROIs. Net operating income is simply annual rental income minus annual operating expenses (excluding mortgage payments and interest rates).