First, what is the average return on real estate investment in the US real estate market? The answer lies in the S&P 500 index. According to this index, the average return on investment in the US is 8.6%. The average rate of return depends to a large extent on the type of rental property. Residential rental properties, for example, have an average return of 10.6%.
Commercial properties, on the other hand, have an average return of 9.5%. A good return on investment in a rental property is usually above 10%, but 5% to 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.
Residential capitalisation rates typically range from 4% to 10%. Using the cash-on-cash 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.
The rule of thumb is that when it comes to investing in rental properties, the ideal is to charge 1 the purchase value as monthly rent. Sometimes a property may look great and seem like an ideal rental, but it may have hidden fees and expenses you hadn't thought of, so analysing your return every time you invest in real estate is a good idea. Whether you're looking at single-family homes or multi-family units as an investment property, know that every property you buy should generate cash flow from day one. 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 based on the income from the property.
Investing in real estate, and more specifically in rental properties, can be one of the most lucrative and secure investments one can make. Needless to say, this is the best tool for real estate investors to calculate the rate of return on a rental property. As you begin your journey as a landlord, take into account the profitability of the property as well as your investment strategy, and you should see a positive ROI from your rental portfolio. In other words, you can take out a mortgage and increase your cash return, leaving open the possibility of using your other funds to buy more property.
Jayne Thompson, a former real estate lawyer, writes on law, business and business communication, drawing on her 17 years' experience in the legal sector. In this way, real estate investors can use the metric to determine the profitability of an investment property at a given point in time. The capitalisation rate is defined as the ratio of a property's net operating income (NOI = rental income - operating expenses) to its purchase price. The best approach to investing is to choose a strategy to achieve your long-term goals and stick to it through thick and thin.
Real estate websites such as Zillow, Trulia, RealtyTrac and the National Association of Realtors regularly publish median sales prices and average rents for homes across the country. Let's break down the basics of investing in rental properties and, more importantly, how to calculate a property's return on investment (ROI).