Unlocking Your Rental Property’s Potential: A Simple Guide to Calculating ROI

Posted on 29 November 2024 Posted in High ROI Strategies, Landlords Advice

Illustration by macrovector_official / Freepik

Property is a popular investment choice for many, especially for those with some extra cash looking for a solid return. But if you’re just starting out, keeping track of all the numbers can feel overwhelming. So, how do you know if you’re making the right investment choice?

The answer lies in a handy metric called Return on Investment (ROI). This simple calculation can help you quickly assess whether a property is worth your time and money. So let’s break down how ROI works and how to calculate it.

What is Investment Property ROI?

ROI measures the potential profitability of a potential property investment. To calculate it, you need to consider:

Potential Costs

Initial Costs / Property Purchase
Taxes
Legal fees
Maintenance fees
Property Management fees

Potential Returns

Rent charges
Capital appreciation over time

Once you have these figures, you can calculate the ROI to see if the property is a good investment.

How to Calculate ROI

The formula for ROI is very straightforward:
ROI = ((The Property’s Estimated Increase in value – The Original Cost of the Property) ÷ The Original Cost of the Property) x 100

Did that make sense??

Here’s an example Calculation

A 6 bedroom house in the popular newland avenue of Hull is for sale at roughly £200,000

To refurbish the property, lets budget for £50,000. This will allow for En-suite bathrooms, electrical rewire, plastering etc.

It has 6 bedrooms each earning roughly £160 per week (all inclusive bills). That’s £160 * 6 bedrooms * 52 weeks in a year = £50000 gross income per year or there abouts.

Lets subtract some costs from that figure. Costs will include:

Energy bills
TV & Broadband
Taxes & Insurance
Costs for maintaining / repairing the property
Property Management Fees if you use a third party to oversea the running of the property for you

On a 6 bendroom house you should budget for around £3500 per rented bedroom = £21,000 costs

Gross £50,000 – £21,000 fees = £29,000 net income per year.

Let’s say you buy this rental property for £200,000. After five years, you sell it for £220,000 and earn £29000 annually in rental income for each of those 5 years. Here’s how the numbers break down:

Selling price increase: £20,000
Rental Income over five years: £145,000 (£29,000 x 5)
Initial investment (because you at least want to get this investment back when you sell): £200,000
Initial Development cost: £50,000 (because you want to get this back also)
Total = £415,000.

Now, plug it into the ROI formula:
ROI = ((£415,000 – £250,000) ÷ £250,000) x 100 = 66% return on investment over 5 years.

You can also calculate the Annual ROI:
Annual ROI = (Annual Gross Income ÷ Total Invested) x 100

Using our example:
Annual ROI = £29,000 ÷ £250,000 x 100 = 11.6%.

What is a Good ROI?

A “good” ROI can vary based on several factors, including:

Location
Market conditions
Investment strategy
Personal goals

Currently, the average annual ROI for investment property in the UK is around 10%, so anything above that is considered better than average.

Conclusion

So the above formulas would suggest that after 5 years you would make £165,000 plus your original investment if you were to sell up. And for a long term investment you can just look at the yearly return of £29,000 per year and you still have a property increasing in value each year as an asset.

Of course, property investing isn’t as straight forward as that and there are many other pitfalls along the way that can have an impact on those figure, nonetheless, understanding and calculating ROI is crucial for making informed property investments. By keeping track of your costs and potential returns, you can confidently navigate the property market and make choices that align with your financial goals.

It’s wise to get a good property management company involved before you buy as they will undoubtedly furnish you with realistic calculations as to what kind of return on your investment you should expect from the property you are proposing to buy. A very good property management agency will even inspect the property for you before you buy and advise on costs for getting the property ready for joining the rental market and even advise against a bad investment, steering you away from a potential failure.

For more information on a good property management company view our video on choosing a proactive property management agency

Or for more advice about getting on the ladder of property investment contact us directly on 01482 342155 and we’ll be able to give you a head start.

Happy investing!