A good return on investment on a rental property is usually above 10%, but between 5% and 10% is also an acceptable range. Remember that there is no right or wrong answer when it comes to calculating ROI. Different investors take on different levels of risk, so it is essential to know your budget and analyse the potential return. The average rate of return on a rental property is around 10%.
Comparatively, the average ROI for commercial real estate is 9.5 per cent and real estate investment trusts (REITs) have an average return of 11.8 per cent. If you are one of the lucky real estate investors who has the money to buy and own an all-cash rental property, then your ROI calculations should be based on the capitalisation rate formula. Depending on how you buy the rental property - all cash or by putting a down payment and taking a mortgage - you can calculate the rate of return using either the cap rate calculation or the cash-on-cash return calculation. The CoC is the ratio of the annual NOI of the property to the total amount of cash invested in the rental property.
However, it can be challenging to figure out the correct ROI calculation, as ROI calculations can be easily manipulated. In reality, rental properties sit empty for a few weeks a year or landlords are left with non-paying tenants. If at any point you realise that your costs and expenses will exceed your ROI, you will have to decide whether you want to hold on and wait for a return to profit or sell to avoid losing out. Next, use the cash return formula and divide the annual cash flow by the total cash actually invested to determine the rate of return on investment (ROI).
So, if you were to finance the same rental property as in the previous example with an equity payment of 20, you would calculate the ROI using the cash-on-cash formula. Knowing the ROI allows investors to assess whether investing money in a particular investment is a smart choice or not. The capitalisation rate in real estate is an ROI analysis metric that calculates the return on investment in terms of how much income is being earned compared to the price of the investment property. The real answer is "it depends", because a reasonable rate of return is subjective to the investor and his or her circumstances, as well as to the circumstances of the property (location, rental prices, risks, etc.).
The capitalisation rate is not the most accurate way to analyse a short-term rental investment, as the value of a short-term rental is based on comparable closed residential properties in the area, rather than on the income from the property. According to the cash-on-cash return formula, you can now expect a 12.6 return on investment from this rental property. Owning a rental property can be a smart way to build wealth, especially if you don't like investing in the stock market. Nicer neighbourhoods tend to have lower rental yields, while tougher neighbourhoods tend to have higher yields.
More and more people are getting into real estate investing and looking to rental properties as a way to diversify their investments and secure cash flow for the future.