Before you buy a rental property, it’s essential to understand if it will deliver a good return on investment – otherwise known as ROI. ROI is one of the most important metrics for landlords and property investors to monitor, as it measures the profit or yield that a rental property will generate in relation to the total investment.
There are many factors that can affect the ROI of a rental property, such as the price of the property, mortgage rates, rental income, running costs and tax or regulation changes. In this article, we explore what ROI is in property investment and how to calculate it.
What is ROI in property investment?
ROI is a useful metric that can help landlords decide whether a property is a good investment. It can help them calculate the profitability of a property and is an excellent way to compare different properties. The higher the ROI, the more financially rewarding a rental property will be. While a low ROI indicates that a property may not be as profitable.
How to calculate the ROI of a rental property
When it comes to calculating the ROI of a rental property, there are five key steps investors can follow. They are:
1. Determine total investment
Factoring in all the expenses of buying a property helps you work out the total cost of investment. This includes the purchase price of the property, stamp duty, legal fees, renovation costs and any marketing or letting agent expenses. If the property is purchased with a mortgage, then only the deposit and initial costs should be included in the calculation.
2. Understand your annual rental income
Knowing how much the property will likely generate in rent each year can help you work out if it is a sound investment. For example, if the monthly rent of the property is £1,200, then your annual rental income will be £14,400. You may also want to factor in the property being vacant for a short period when you are in between tenants.
3. Deduct your annual operating expenses
These are the yearly costs, such as mortgage interest payments, maintenance at the property, any insurances, letting agent fees and service charges for leasehold properties. Knowing these can help you better calculate your ROI.
4. Work out your net profit
To work out your net profit, you need to deduct your annual operating expenses from your annual rental income. This gives you your earnings from the rental property before you’ve paid tax.
5. Calculate your ROI percentage
To calculate ROI as a percentage, divide the net profit by the total investment and multiply it by 100. For example, if you purchase a rental property for £250,00 with £15,000 upfront costs and the annual rental income is £18,000, but you have £3,000 annual operating expenses, your ROI percentage would be 5.6 per cent.
What is a good ROI?
As a general rule, the following can help you determine if investment in a rental property is worthwhile:
- < 5% suggests a weak return on investment
- 5-7% is a good return and the average for most properties in the UK
- >7% is a strong return
Are you considering renting out a property in 2025?
Whether you are a seasoned landlord or thinking of buying your first rental property, our award-winning team can help you with every step of letting a property. At Shortland Horne, our friendly team can support you with everything from market appraisal to referencing tenants. Get in touch today to see how we can help.