How Much Profit Should You Make On A Rental Property: The Facts
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Before purchasing a property for cashflow purposes, consider the question: How much profit should you make on a rental property?
Those who are new to the world of investing usually start by renting out a single room within their home or by purchasing a rental property. Some may decide to hire a property manager to help with the management, which leaves them time to focus on other properties and growing their portfolio.
What you don’t want, however, is to go underwater on your investment. That’s why knowing the profit first can come in handy. As such, we’re focusing on discussing profit, and how you can make sure you get more than just a return of investment.
How Much Profit Should You Make on a Rental Property
If you want to be a successful landlord and not one who struggles through each tenancy, then knowing the profit beforehand is crucial.
To decide how much profit you should make on a property, you need first to consider a few factors. These will help you determine the correct amount of rent to set for your room or property.
Deciding the profit amount relies on four main factors, including rental rate, overall expenses, and the market it’s situated in.
How to Determine Profit
When it comes down to profit margin on a rental property, you want to follow the 2% rule at minimum. Meaning if your rent is 2% of the purchase price, your property has a good chance of generating positive cash flow.
That said, there are other factors at play. And here are the things you should learn for you to determine the profit you can earn from the property:
1. Market’s Rent Rates
First things first, the market is key to your property’s overall success. If the market is poor, then your property may struggle to cashflow. When it comes to selecting the market you’d like to invest in, you should try to ensure it’s a successful one for rental properties.
At this stage, you should already have a rough idea of your budget and what you can afford. You should narrow your focus on markets with average prices that fall within your budget. This will allow you to get the best price for your property.
Once you have identified a couple of markets that you are interested in, research data on each one to discover the rents in each market. The higher the rent price is, the higher the price you can set your own rent.
A good way to obtain such information is through real estate agents, property management agencies, or even online. Some city municipalities may also have information.
Doing your research on the markets beforehand gives you a better idea of the market to choose, and makes sure you are better informed on various options.
2. Extra Expenses
When it comes to finding out how much profit should you make on a rental property, researching the markets to compare pricing strategies isn’t enough.
Why is this the case? That’s simple. Rent isn’t the only thing to consider. You may find the perfect property which is totally within your price range, yet its insurance, tax, and other costs are too expensive, so the result is poor cash flow.
Take the time to account for any extra expenses that may interfere with the rental price. This can include factors such as:
- Tax on rental income
- Management and maintenance of the property
- Property insurance
- Other taxes
Once you have a clear idea of all these extra expenses, you won’t be surprised when they pop up unexpectedly in a property’s price. This will also allow you to make a better judgment of the final profit when you know exactly what costs are involved.
3. Calculating Your Returns
Once you’ve determined the property’s price, the rent, and all other extra expenses, you can use this information to understand the profit you should expect to earn at the end of the process.
At this stage, there are three important factors you might want to consider, including the following:
- Property cash flow
- The cash-on-cash return
- The cap rate
When speaking about a property’s cash flow, we mean the rental income minus any expenses.
Properties that feature a good cash flow will have an annual rental income that is higher than the number of annual expenses.
For newbies, negative cash flow is when annual expenses are higher than rental income. This obviously results in you not making any profit whatsoever. Womp. Womp.
- Cap Rate
It is a metric which is used to determine returns and decide the profit amount that you will make after investing in a property. To find the cap rate, simply divide cash flow by the property’s value, and then multiplying the result by 100.
This equation helps you to determine the amount of profit you should earn on a property according to its price.
- Cash-on-Cash Return
This is another metric similar to cap rate but it only considers the amount of money being invested into the property. This can be found by dividing cash flow by cash invested and then multiplying by 100.
All of these metrics can help you to discover any projected returns from a property based on its rental income. Doing this will allow you to understand the profit you should receive so that you can adjust your rent to the right level, and make the most of your investment.
Whether you are a beginner or an experienced rental investor, knowing the profit you could potentially earn on a property beforehand can save you both time and money. Not knowing the profit is like walking into a deal blind without any guarantee that it will be a success.
If you need more info before you jump into buying a rental property…fear not! There are many great books that can guide you through the process. However, if you’re a beginner, and looking for a complete guide, we recommend this book by Lisa Phillips.