Whether renting properties is your side hustle or your primary source of profit, it is a great way to generate passive income. While managing your rentals and finding prospective renters is easier said than done, there will come times in which you can enjoy some peace of mind. If you are new in the business, you are properly wondering how much money you should make on a rental property. Although it is necessary to know your profit margin regardless of the type of business that you’re leading, there isn’t usually a solid answer, especially in the world of rental properties. Since this is a personal question, you are the only one who can determine your business’s profit margin. However, we collected 6 important tips that can help you out.
1. Consider the Risk
When you want to determine an acceptable profit range, you must always think about the risks involved. With every business comes a risk; understanding how great it is can help you put a number on the deal. To identify the significance of the venture, you need to find out whether you will need to spend a large sum of money on repairs. You also need to get insight into other tenants’ rents, as well as the general situation of the rental’s neighborhood. It’s smart to figure out a way in which you can add value to the deal. Once you are able to answer these questions, you will get a clearer picture of whether the deal is right for you and your skills.
2. Positive Cash Flow
There are generally several ways to make a profit upon investing in real estate; popular cash flow is one popular method. Cash flow is the amount of money that you have at the end of each month after you collect income, cover all your operating costs, including the property’s price, mortgage payments, rental rates, maintenance costs, property taxes, management, and insurance, homeowners association fees (if applicable), and set cash aside for future repair expenses. In simpler terms, it can be expressed as cash on cash return. You can tweak the cash flow model if any of the expenses can be tipped in your favor, thus generating more profit.
3. Loan Pay Down
Loan paydown is the other aspect of profit generation. A part of your mortgage payment goes toward the principal balance if you are using leverage; your tenant pays down your loan every month. Your equity is the difference between the property’s worth and the mortgage balance, and your profit is the difference between the money that you paid for the profit and the equity.
4. Calculate Cap Rate
To determine your real profit, there are generally 3 metrics that you should calculate: cap rate, cash flow, and cash on cash return. You can either use a return property calculator or do the calculations on a spreadsheet or by hand. To calculate the cap rate, you need to write down the years’ expenses less the mortgage payments and add them up. Add up your years’ income too. Subtract your expenses from the income; if you are left with a positive value, that’s your NOI or net operating income. Divide this number by the price that you purchased the property for, then multiply by 100 to get your cap rate.
5. Average Monthly Cash Flow
To calculate your average monthly cash flow, start by subtracting your NOI from your annual mortgage payments. At this point you will be left with the annual cash flow; you are on the safe side if you are left with a positive value. You should then multiply this number by 12 to get the average monthly cash flow.
6. Cash on Cash Return
Lastly, to calculate your cash on cash return, divide annual cash flow by your down payment, if you are indebted, or purchase price if you paid in cash. Then, multiply this number by 100. If you used debt to finance your property, then your cash on cash rate will be different from your cap rate. If you paid the amount in cash, then it will be the same as the cap rate.
Determining how much profit you should be making out of your rental property is a deeply personal issue. This is because everyone encounters different risks, obtains different deals, and pays and receives a different amount of money. Each property is unique, which is why there are so many factors to consider as you attempt to find out your rental business profit margin. This is why we gathered tips that will help you grasp a better understanding of your business’ performance.
