May 12, 2025 | 3 Minute Read
When evaluating a rental property, it’s important to determine if it will generate income—and whether that income justifies your initial investment. A straightforward way to determine this is by calculating the Return on Investment (ROI). ROI reveals whether the rental income will yield a solid return or a loss compared to your upfront costs.
What Is ROI in Real Estate?
ROI (Return on Investment) measures a property’s profitability. It compares your net rental income to your total investment to show how efficiently your money is working.
Investors use ROI to compare different properties and avoid deals that drain cash instead of generating income. A strong ROI signals a worthwhile investment; a weak ROI suggests it may be better to move on.
How to Calculate ROI
The basic ROI formula is:
ROI = (Annual Returns) ÷ (Total Investment Cost)
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Annual Returns = Total rental income – Operating expenses
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Investment Cost = Down payment + Repair/renovation costs + Closing costs
Example:
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Annual rental income: $15,000
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Annual expenses: $8,000
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Net income: $7,000
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Total upfront investment: $48,000
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ROI = $7,000 ÷ $48,000 = 0.1458 (or 14.58%)
A 14.58% ROI is considered excellent.
Most investors use multiple calculations alongside ROI to get a full picture:
Net Operating Income (NOI)
NOI = Rental Income – Operating Expenses
NOI measures profitability before financing costs (like mortgage payments). It includes all income sources (rent, parking fees, laundry machines) and operating expenses (repairs, management, insurance, property taxes). It excludes loan payments, depreciation, and taxes.
Cash-on-Cash Return
Cash-on-Cash Return = Annual Pre-Tax Cash Flow ÷ Total Cash Invested
This tells you how much profit you’re earning compared to how much cash you put into the deal—ideal for evaluating real-world returns, especially for financed deals.
Annual Cash Flow
Annual Cash Flow = Total Income – Total Expenses
This simple metric shows how much money the property generates after all costs are paid.
Cap Rate (Capitalization Rate)
Cap Rate = NOI ÷ Current Property Value
Cap rate measures your return relative to the property’s current market value. It’s useful for evaluating whether the investment is still worthwhile in today’s market or if adjustments are needed.
Gross Rent Multiplier (GRM)
GRM = Property Price ÷ Annual Gross Rent
GRM estimates how long it will take for the rental income to repay the purchase price. It ignores expenses, so it should be used alongside ROI and other metrics.
What’s Considered a Good ROI?
Most real estate investors aim for an ROI between 8% and 12%.
U.S. Average ROI Benchmarks:
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Residential rentals: 10.6%
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Commercial properties: 9.5%
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REITs: 11.8%
These are general benchmarks—market conditions, property type, and location can significantly influence results.
Factors That Affect ROI
Several variables can boost or reduce your return:
Rental Income Potential
You can often raise rents to match local market rates, especially if previous rents were underpriced.
Purchase Price and Upfront Costs
Higher purchase prices or large down payments lower ROI. Analyze whether higher costs are offset by long-term gains using other metrics like GRM.
Location
Location heavily impacts rental demand, vacancy rates, and appreciation potential. Prime areas may be more expensive but offer better returns over time.
Interest Rates
Investment loan rates are usually higher than for primary residences. Even a small rate increase can significantly affect monthly cash flow and ROI. Improve your credit score to qualify for better terms.
Operating Expenses
Some properties have higher costs due to management fees, maintenance, taxes, or utilities. High expenses shrink your profit and lower ROI. Asset class matters too—hotels and restaurants typically have higher ongoing costs.
ROI is one of several key tools for evaluating rental property profitability. While a strong ROI (8–12% or higher) is a good sign, you should also consider NOI, cap rate, cash flow, and location to make a fully informed decision.
If you’re ready to move from analysis to action, REIBrokers.com can help. We provide flexible loans for rental and vacation properties with fast approvals, competitive rates, and tailored support for real estate investors.