Rental properties have the potential of generating consistent revenue for rental property owners. With as volatile as investments can be at times, having something that offers consistent revenue is a home run in the investment world.
But knowing what the return on investment (ROI) is for your rental property is key. There are a few factors to take into account to know what the potential for your rental property is and what you need to get out of it to make it a worthwhile investment.
Cap Rate
The cap rate is basically the profit that you can make from net income that is generated by the property. A good example of this is buying a home for $200,000 and renting it out for $1500 per month. When you factor in your expenses — such as repairs, taxes, insurance, etc. — it comes out to around $500 per month.
So, your property’s net operating income is $1000 per month, which comes out to $12,000 per year. Divide that $12,000 into your initial $200,000 investment and you have a 6% cap rate. Determining what cap rate you can get and how it works for you determines how successful that property is for you.
One-Percent Rule
People who are evaluating rental properties as an investment generally use what is known as the one-percent rule. This means that if the gross monthly rent (before expenses) is equal to at least 1% of the purchase price of the property, it is generally seen as worth looking into.
Under this rule, a house would bring in a gross revenue of 12% of the purchase price each and every year. With expenses involved, that would bring a net revenue of around 6% to 8% of the purchase price, which is generally considered to be a good return.
Of course, these are just guidelines to investing in rental properties. You can determine what makes an investment worthwhile to you and go from there. Starting lower may be a great way to introduce yourself to being a landlord, growing your percentage as you go.