The amount of profit you need to make from a rental property

Have you ever pondered the ideal return on a rental property? If you have some spare money to invest and are thinking about buying a rental property, you should first weigh your expected income versus expenses before making the investment.

I’ll analyze and break down each of my three rental properties, which I’ve owned for three to four years, in detail in this piece, including costs, cash flow profit, and equity.

What You Should Know About Real Estate Investing

To make wise selections regarding your investment, you should keep a number of different elements in mind when determining how much profit you should make on a rental property.

Refinance with Cash-Out

When the value of your house or the equity you have in it rises, you can get a cash-out refinance. This enables you to obtain a new mortgage loan for a sum that is higher than your existing loan. The difference between these loans can then be withdrawn in cash. In essence, you are converting a portion of your equity into money. The money can then be used for anything you like, such as house renovations or further investments in real estate.

Regular Financing

When purchasing a property, most individuals consider traditional finance. In order to finance your purchase with this method of financing, you obtain a mortgage from a financial institution and repay it over time. This kind of financing typically has better lending terms for the buyer and is more cheap.

Unsecured Loan

Private companies or individuals provide the money for hard money loans. They typically have longer periods, greater fees, and higher interest rates. It functions best for homes that require considerable remodeling. However, it can be worthwhile if you know that after the improvements are finished, the property’s value would skyrocket.

Contract A Property Manager

All three of my properties are managed by a firm I pay for. By hiring a management business, you may avoid worrying about renters, rent collection, evictions, contractor scheduling, and other associated difficulties.

You can be hands-off and manage all of your properties without spending much time by hiring a manager to handle this. Of course, hiring a property manager will reduce your profits if you’re thinking how much you should earn on a rental property.

Background Regarding My Rental Residences

In the years 2016 and 2017, I acquired all three of my rental homes. Although they are all in desirable areas and of excellent quality, they are all priced below the city’s median. Each property in San Antonio is presently valued between $130,000 and $190,000, with the average price point in the city being around $225,000. I’ve broken down the costs and expenses of each rental property below to show how much profit you should expect to make.

Sunrise Creek

1,086 square feet in size
Date of Purchase: 03/17/2017
Cost of acquisition: $66,887
Financed Amount: $80,000
Down payment: -13,113 dollars
$2,000 Closing Costs/Commission
Rehab: $31,769
$20,663 was invested in whole in cash.
Value today: $130,000
This house was for sale in a poor situation and required significant remodeling. After subtracting the $2,007 I earned in closing expenses, the amount I paid for the property was roughly $100,000. I paid $66,887 for it and spent $31,769 on renovations. The repairs required will have an impact on how much money you may expect to make from a rental property.

One of my family members who was getting ready to relocate out of state donated this house. I made the decision to acquire the property myself and negotiate a deal with the seller because it was not in a condition to be sold to a retail customer.

The terms of the agreement stipulated that the seller would keep his or her name on the deed and continue to pay the mortgage. But until I had finished the home’s renovation, I would cover their mortgage payments for them. I only agreed to this agreement because I was dealing with a relative and was confident in the outcome.

After I finished the renovations, I would put 20% of the home’s after-rehab value (ARV) down to buy it as a conventional investment property. I could avoid taking out a hard money loan and then refinancing the property once it was finished thanks to this structure. The difference between my original purchase price of $66,887 and the home’s final after-rehab value of $100,000 would then constitute my claim against the seller.

I used my own money to finance a down payment of $20,000 (20% of the $100,000 ARV). This total out-of-pocket expense, including the $30,000 in repairs, is $50,000. My actual out-of-pocket expenditure, however, was only $20,000 because the seller sent me a check for close to $30,000 following closing. The property has a $80,000 loan on it.

The property’s actual market worth, however, has risen over time and is currently $130,000. Today, after deducting the cost of the loan, I have about $55,000 in equity.

Thatch Drive

1,360 square feet in size
Date of Purchase: 8/12/2016
Cost of acquisition: $119,200
Financed Amount: $95,360
Embezzlement: $23,840
Costs of closing and commission: $3,576
Rehab: $6,393
$33,809 was invested in cash total.
Value today: $187,360
Because they chose a speedy close and did not want to bother with showings, I bought Thatch Drive from one of my clients for $119,200.

I secured $6,000 in closing fees from the seller and made $7,000 in real estate commission. I paid $23,840 out of myself, or 20% of the $119,200, as the down payment. This sum, along with the remaining closing charges of $3,576 and the rehab expenses of $6,393, made my out-of-pocket expenses total $33,809.

Over the years, Thatch Drive has appreciated in value and is now worth roughly $187,360. The $95,360 initial loan I made for it. I have about $100,000 in equity in the house after subtracting my loan from the market value.

Windward Way

1,360 square feet in size
Date of Purchase: 03/27/17
Cost of acquisition: $63,000
Financed Amount: $100,000
Low-ball Offer: $37,000
Amount Due at Closing: $1,890
Rehab: $38,931
$3,821 was invested in cash total.
Value today: $139,000
There were many issues with this home. I paid $63,000 for it, and the repairs cost $38,931.

I obtained a $100,000 private loan with a 5.5% interest rate for this property. This was a personal loan from a person I know who needs to invest part of their money in a reasonably secure investment rather than hard money or regular financing.

The loan covered the majority of the repair and closing expenses, which were minor because it was a cash purchase, because it was higher than the property’s purchase price. As a result, I only had to pay $3,821 out of my own cash for the property.

The property is currently valued about $139,000 today. I currently owe $95,482 on a $100,000 loan, which means I have about $43,517 in equity.

For all three properties, total rehabilitation plus appreciation returns
Equity total: $197,953.19
Payout total: 57,536.64 dollars
I paid about $57,536.64 in cash out of my own pocket for these homes, and after about four years, I had just about $200,000 in equity, making them a great investment.

Two of these properties required extensive renovation. I’d say that 50% of my entire return comes from rehabbing the properties, and the other 50% comes from appreciation.

When determining how much profit you should make on a rental property, you need also take into consideration the cash flow in addition to renovation and appreciation.

What Should The Profit On A Rental Property Be?

I had the option of flipping these houses, but I chose to keep them and rent them out instead. I’ve been making regular cash flow on each of them as a result. As the value of the properties rises over time, I also gain greater equity.

I keep track of all my revenue and expenses for the three properties using Quickbooks. The cash flow profit you should expect from a rental property is shown in the table below. I pay particular attention to the cash flow from 2018 to 2020.

Analyzing My Properties’ Cash Flow from 2018 to 2020
I started renting the houses in 2017, thus the first full year of data began in 2018. I’ve had three tenant changes since the end of 2020: one in Windward Way and two in Sunrise Creek. There were no tenancy changes in Thatch.

Keep in mind that property management is responsible for all three homes, therefore I have no involvement. Through email notifications, I am informed of things like required maintenance or when a tenant won’t renew their lease. The rental money, less property management fees and any maintenance costs incurred that month, is sent to me by direct deposit every month.

I also pay for insurance, yearly taxes, and any capital improvements that the property requires. Significant spending that are not related to routine maintenance are capital expenses. For instance, I had to rebuild a portion of the electrical system within Windward Way as well as the roof of Thatch Drive in 2018.

These three investment properties have generated a combined $21,708.33 in cash flow throughout the three full years that I have owned them. This comes to $2,412 per property per year or $7,236 for the three properties as a whole. This indicates that each property generates a monthly cash flow of about $200.

If you examine each property separately, you’ll see that some have done better than others. This is a result of the capital expenses I made on Thatch Drive and Windward Way.

Four Costs To Take Into Account

Real estate is normally a great investment, but you must keep in mind that there will be numerous costs. It might not be the best moment to invest in real estate if you cannot afford to take these into account.

Vacancy

In all likelihood, you won’t be able to pay the rent for the entire year. Even if the home is rented out right away, the tenant must still be authorized, so rent payments might not start coming in right away.

Additionally, if it isn’t immediately rented out, it needs to be advertised and staged while you look for a tenant. It is advisable to set aside 10% of your income for vacancy because of this. As an illustration, let’s assume you charged $2,000 on the rental property while making a $1,800 mortgage payment. You would be breaking even with your $1,800 mortgage if you subtract $200 or 10% of that sum to account for vacancy.

On the previous profit and loss statement, vacancy is not listed as an expense. However, depending on the amount my properties rent for, my gross rent over the course of three years would have been closer to $127,000 if there were 100% occupancy. I lost about $5,000—just under 5%—to vacancy. But because the rental market in my city has been expanding, I’ve also avoided having to deal with eviction. Because of this, I still advise you to account for 10% of vacancy.

Maintenance

For maintenance, I set away 5% to 10% of my income. It’s safe to reduce the risk to 5% if the property is more modern and has been well-maintained or recently renovated. In contrast, 10% is preferable for older properties that require routine upkeep.

I’ve spent $6,655 on maintenance for all of my homes during the past three years. This sum represents around 5% of the $122,282 in gross rent I have received throughout the same period.

Capital Investments

It’s a good idea to set aside 5% to 10% of your income for capital expenses. This cost typically represents a major fix that the property will require over the course of its lifetime, like a new roof or AC unit.

Because of this, it’s a good idea to budget and save money so that you can pay for them when the time comes. $10,287, or little under 10% of my total gross rent, has been spent on capital improvements.

Fees for property management

I also budget 10% of my income for the cost of property management. You won’t have to worry about this if you want to handle the property on your own. However, if you prefer to take a more passive approach to your investment, this can be a cost that is justified.

My contract with my property management business is excellent. Over the past three years, I’ve paid $10,617 in property management costs, or just under 10% of my gross rent.

Proper Cash Flow Forecasting

40% of the rent you receive from such property must be deducted if you take into account 10% for vacancy, 10% for property management, 10% for capital expenses, and 10% for upkeep. For instance, you would now be making $600 instead of $1,000.

Therefore, you probably won’t be cash-flow positive if your mortgage is more than $600. You will, however, have a cash-flowing asset if it is lower.

Total Return on Investment is evaluated

You must account for forced appreciation from renovation, passive appreciation from real estate value growth over time, and cash flow gained (or lost) throughout the years when calculating your total return on investment.

Before I buy any offers, I run the numbers with a free program called Dealcheck. For investor clients who want to examine their prospective profits for a certain property, this tool is also fantastic. Additionally, you can use this tool to determine whether it would be better for you to hang onto an investment rather than sell it and utilize the proceeds to purchase another asset.

Simply enter some raw data into the system, such as the purchase price, renovation costs, financing information, and anticipated expenses.

Buy-and-hold forecasts

DealCheck may provide a report called “Buy and Hold Projections” that displays your anticipated profits across various ownership periods. Examples of the report for my three rental homes are shown below.

Sunrise Creek
Thatch Deive
Windward Way

Whether you hang onto your property for one year or 30 years, your returns are broken down in this study. It takes into account cash flow and equity growth and compares them to your initial investment to illustrate the return on investment if you sell the property at a particular point in time.

To figure out how much profit you should make on a rental property, I suggest examining two metrics:

Income From Equity

Based on the amount of equity I have in the property, this is the return I receive in cash flow. This figure should ideally be greater than 4%. If it’s lower, you ought to think about refinancing the house, taking cash out, or selling it and reinvesting the proceeds.

Since real estate appreciates at a rate of around 3% over time, I strive for 4%. The 4% cash flow multiplied by the 3% appreciation results in a 7% overall return on your equity. Any less than this, and you’d be better off investing the equity in something that pays a greater dividend.

Rate of Return Internal

The annualized % return on my investment throughout the course of my holding period is indicated by this number. For instance, if you check at Windward Way, you’ll notice that after five years, my $3,821 initial investment will have generated an annualized return of 108.6%.

Compounding is taken into consideration by the internal rate of return. As you can see, a total return of 2,095.3% was earned over the course of those five years. Wow, what a great investment!

Is real estate investing the right choice for you?

When calculating your cash flow, consider the four costs we discussed above in addition to your mortgage to establish how much profit you should make on a rental property. It’s imperative to perform these calculations prior to making an investment. In this manner, you can determine whether the property is a wise investment.

As a general guideline, if you can rent out a home for 1% of what you paid for it, it might be a wise investment. And if you can achieve even just 2% more, that is a fantastic opportunity to diversify your portfolio with a cash flow-positive investment.

Remember that even if the cash flow is neutral or negative, a property might still be a wise investment when calculating how much profit you should make on it. This would be the case if you predict that the area’s appreciation will rise above the national average.

I’ve seen that rental homes in lower-income neighborhoods typically have higher cash flow but less appreciation. Rental homes in higher-income areas, on the other hand, appreciate more but generate less cash flow.

Aside from the income flow, another benefit of real estate investing is the tax advantages. Some costs, including maintenance, property management, and depreciation, are deductible. Depreciation has many advantages, including the ability to produce revenue from the asset and write off a large portion of it thanks to depreciation.

Last Words On Becoming An Investor In Real Estate

Real estate investing can be a profitable method to increase your wealth, if you can afford it. This case study of my three homes should have shown you how much profit you ought to expect from a rental property. Use the advice in this article to help you invest wisely in real estate and choose wisely how to spend your money. Check out my piece on 10 financial independence tips for real estate agents for more guidance.

Have you ever made a real estate investment? If so, how did that go for you? Tell me in the comments section below. I would adore hearing from you!