How Much Profit Should You Make on A Rental Property?

We take a look at the different factors that go into determining how much profit you should make on a rental property.

Rental properties can be a great way to make passive income, but it’s important to know how much profit you should be expecting from your investment. Knowing how much of a return you can expect from a rental property will help you make informed decisions about your investment.

In this article, we explore the different factors that go into determining how much profit you should make on a rental property. We’ll discuss how to calculate rental income, expenses, and net profit. We’ll also provide guidance on how to achieve a profitable return on your rental property investment.

Determining if it’s a good investment

Calculating how much profit you should make on a rental property is one of the first things you need to do to determine if it’s going to be a good investment in the long term. This involves taking into account the expected rental income, any potential expenses, and the associated tax implications.

The property’s cash flow, however, will ultimately depend on a number of factors, including your initial investment, the type of property and its location. For instance, a single-family home in a desirable neighborhood will likely generate higher rental income than a single-family home in a less desirable area.

A few other factors to keep in mind when evaluating an investment opportunity:

  • Initial investment: How much money will you be putting up and for how long? An amazing ROI might not be worth it if you’re spending every penny of your savings to purchase the home, leaving no room for error.
  • Property condition: If the property is going to need significant repairs or updates in the near future, calculate these costs into the purchase price of the home.
  • Rent-to-mortgage ratio: If you’re investing in a rental property, do the math to make sure the numbers have you coming out on top. If the expected rent payment is not going to cover your mortgage, insurance, taxes, and association dues, then it’s not a good investment.
  • Property location: You can change a lot of things about a property, but you can’t change the neighborhood it’s located in. Even the nicest house in the worst neighborhood might not turn out to be a profitable investment.

Common rental property expenses

Rental property operating expenses are those necessary costs that come with owning a rental property. These expenses include things like mortgage payments, repairs and maintenance, insurance, taxes, payroll and marketing costs.

Mortgage payments are necessary to pay off the loan used to purchase the property. Taxes and insurance are necessary to ensure the property is legally compliant and protected from any potential liabilities. Repairs and maintenance are essential to keep the property in good condition and up to code. Payroll costs are necessary to cover the wages of any employed staff, and marketing costs are necessary for advertising the rental property and finding new tenants.

In addition, rental property owners may also incur additional operating expenses such as utilities, cleaning and landscaping costs, HOA fees, and other miscellaneous expenses.

Utilities are costs associated with providing electricity, water, and other services to the rental property. Cleaning and landscaping costs may be necessary to keep the property looking nice and well-maintained. HOA fees are applicable if the rental property is located in a community with a Homeowners’ Association, and may include dues and other charges. Miscellaneous expenses may include legal fees, accounting fees, and other costs associated with owning and operating a rental property.

Related: A complete breakdown of your schedule e expense categories.

How much rent should you be charging?

One of the first things landlords need to figure out is how much to charge for rent. Having a cash flow positive business is essential if you want to expand operations, and this means having little to no vacancy. To do this, you have to set a price that is attractive to tenants while still bringing in the most money.

A few tips for working out how much rent to charge include:

  • Do a rental market analysis comparing your property to like properties in the area. You can use software like RentRange, Rentometer, and Zillow Zestimates.
  • Research the demand and supply in the area. High demand and low supply will allow you to charge more.
  • Calculate operating costs. Knowing how much you’re going to need to spend will allow you to work out the minimum you can viably charge whilst still making a profit.
  • See how much interest you get. If your property doesn’t get many enquiries, then think about lowering the rent amount.

How to Determine Profitability of Real Estate Investments

There are several commonly used metrics used to calculate the return on your real estate investment and help you keep your property profitable over time.

Return on Investment (ROI)

Investors and experts alike regard return on investment (ROI) as the most important aspect of evaluating the profitability of a real estate investment. It is generally recommended to aim for an ROI of at least 15%. However, the ROI that is considered “good” or “bad” is dependent on an individual’s financial standing and the particular property they choose to invest in.

For example, you spend pay $20,000 in closing fees and maintenance/repair costs and when the property is ready to hit the market, you charge your tenants $2,500 per month. If you divide your income by your expenses, your yearly ROI would be just over 7%

Cash-on-Cash Return

The widely used real estate investment metric of cash-on-cash return (CoC) measures the yearly return on an investment based on the cash invested and net operating income. This return rate may differ greatly depending on the financing method employed, e.g. cash purchase or loan. Generally, it is advised to strive for a CoC yielding between 8% and 12%.

Capitalization Rate

The capitalization rate (also known as cap rate) in real estate is the ratio of net income to the purchase price of the property. To illustrate, a property worth $200,000 that is rented out at $1,500 monthly would give an annual net operating income of $12,000, which is equivalent to a cap rate of 6%. Whether this rate is beneficial or not depends on a variety of factors. For instance, a 6% rate may not be worth it if the neighborhood is not desirable or has a high risk or potential safety concerns. On the other hand, if the area is in high demand and the tenants are trustworthy, 6% can be a great return on investment.

The 1% Rule

The 1% rule is a helpful tool for investors to evaluate the viability of a potential investment property. The rule states that the monthly rent should be at least 1% of the total purchase price. For instance, if a property is bought for $300,000, it should generate a minimum of $3,000 in monthly rent. If market prices are lower than this or seem unreasonable, the investment may not be worth it. Additionally, factors such as size and location should be taken into consideration.

Final Words

Finally, you should consider the tax implications of owning a rental property. Depending on the property’s profitability, you may be able to deduct expenses from your taxable income.

Additionally, you may be able to take advantage of capital gains tax benefits if you decide to sell the property. Once you’ve taken all of these factors into account, you can calculate your potential profit. The amount will depend on your specific situation, but a good rule of thumb is to aim for at least 10% profit after all expenses and taxes. While 10% is a good target, you may be able to make more depending on the property and the rental market.

Ultimately, it’s up to you to decide how much profit you want to make on a rental property. Just be sure to factor in all of the costs and taxes associated with owning a rental property and make sure that you’re still able to turn a profit.