How to calculate ROI on a rental property?
ROI is a financial metric that measures the return generated from an investment relative to its cost. The formula for calculating ROI is:
ROI = (Net Profit / Total Investment) x 100
Calculate Total Investment:
Total investment includes both the initial purchase price of the property and any subsequent costs incurred for renovations, repairs, or improvements. It also includes closing costs, loan fees, and any other expenses directly related to acquiring the property.
For example, let's consider a rental property with a purchase price of $250,000, closing fees of $10,000, and renovation costs of $20,000, bringing the total investment cost to $280,000.
Total Investment = Purchase Price + Closing Fees + Renovation Costs
Total Investment = $250,000 + $10,000 + $20,000
Total Investment = $280,000
Determine Net Profit:
To calculate net profit, subtract all expenses associated with the rental property from the total revenue generated. This includes operating expenses, vacancy costs, property taxes, insurance, maintenance and repair expenses, and mortgage payments (if applicable).
For instance, if a property generates $35,000 in rental income and incurs $10,000 in operating expenses (including property taxes, insurance, maintenance, and management fees), the annual net profit of that unit would be $25,000.
Net Profit = (Rental Income + Other Revenue) - Operating Expenses
Net Profit = $35,000 – $10,000
Net Profit = $25,000
Plug these numbers into the ROI formula mentioned above. The resulting figure represents the percentage return on the investment made in the rental property.
ROI = (Net Profit / Total Investment) x 100
ROI = ($25,000 / $280,000) x 100
ROI = 8.93%
The calculated ROI is essential for assessing the profitability of your rental property investment. In our example, an ROI of 8.93% indicates that for every dollar invested, the property generates a return of 8.93 cents annually. A positive ROI indicates that the investment is generating profits, while a negative ROI suggests a loss.
Breakdown of Property Management Fees
There may be other revenue streams associated with rental property. Typically, Other Revenues may account for approximately 5% to 10% of the total revenue.
These additional revenues can come from various sources, such as:
1. Maintenance Fee: Typically, it is 1% of the property's annual assessed value. It is the fee collected for maintaining properties. Property managers alter that pricing in accordance with their expertise.
2. Late Fee Income: Fees imposed on tenants for late rental payments. In order to make up for having to go after the tenant to collect unpaid rent, some property management companies will take 25% to 50% of the late charge collected.
3. Utility and Renovating Reimbursements: Reimbursements received from tenants for utilities such as water, electricity, or internet services. Many management organizations may charge a project management fee of about 10% of the project value if you're renovating your property significantly in order to make sure the work is done correctly.
4. Pet Fees: Charges for allowing pets on the property.
5. Parking or Storage Fees: Additional charges for providing parking spaces or storage units to tenants.
6. Laundry or Vending Income: Revenue generated from laundry facilities or vending machines available on the property.
7. Advertising or Sponsorship Income: Income generated from advertising opportunities or sponsorships within the property.
How to calculate NOI in multi-family?
The Net Operating Income is a financial metric used to calculate the profitability of an income-generating property. It is calculated by subtracting operating expenses from the revenue generated while running and maintaining a property. The revenue includes rental property income and other income, while the expenses include insurance, taxes, utilities, property management fees, and maintenance costs.
Net Operating Income = Gross Operating Income – Operating Expenses
Step 1: Gather Income Information
This includes the total rental income generated from all units, income from parking fees or additional services, and any other sources of revenue. For example, let's consider a multi-family property generating $15,000 per month in rental income and an additional $1,500 per month from parking fees.
Step 2: Determine Vacancy Rate Next, determine the vacancy rate for your multi-family property. The vacancy rate represents the percentage of unoccupied units or potential rental income that is not realized. For this example, let's assume the vacancy rate is 10%.
Step 3: Calculate Effective Gross Income (EGI) To calculate the Effective Gross Income (EGI), subtract the potential rental income lost due to vacancies from the total income. In this case, the EGI would be $15,000 (rental income) - $1,500 (vacancy rate of 10%) = $13,500.
Step 4: Identify Operating Expenses Identify and gather all operating expenses associated with managing the multi-family property. This includes property taxes, insurance premiums, maintenance and repairs, utilities, property management fees, and other relevant costs. Let's assume the total operating expenses amount to $4,000 per month.
Step 5: Calculate Net Operating Income (NOI) To calculate NOI, subtract the operating expenses from the Effective Gross Income (EGI). Using the example figures, the NOI would be $13,500 (EGI) - $4,000 (operating expenses) = $9,500.
Step 6: Analyze and Interpret NOI The calculated NOI of $9,500 represents the property's profitability before considering interest, taxes, depreciation, and amortization.
What are the components of multi-family NOI?
Using the data from NAAHQ survey conducted in 2020 for better understanding, here’s what to consider in the revenue and expense while calculating NOI for multi-family homes:
1. Gross Potential Revenue: Gross profit revenue encompasses all income generated from the rental property, excluding operating expenses and non-revenue items. It includes the rental income, fees from additional services, and any other income directly related to the property's operation.
According to NAAHQ survey, GPR for mid- and high-rise apartments is $21K per year.
2. Rent Revenue Collected: Rent revenue collected represents the monthly rental payments received from tenants. On average, Rent Revenue Collected may range between 90% to 95% of the Gross Potential Revenue, and according to NAAHQ it is around $20k per unit per year for mid- and high-rise apartments.
Breakdown of Multi-family Operating Expenses:
1. Salaries and Personnel: Salaries and personnel expenses encompass the costs associated with property management personnel. This includes wages, benefits, payroll taxes, and any additional costs related to personnel management. According to NAAHQ, it all adds up to around $1500/unit/year for multifamily apartments.
2. Repairs and Maintenance: Repair and maintenance expenses cover the costs of routine repairs, preventive maintenance, and property upkeep. These expenses sum up to around $400/unit/year. This includes expenditures on repairs, renovations, landscaping, cleaning services, and any necessary repairs to keep the property in good condition and attract and retain tenants.
3. Advertising and Marketing: Advertising and marketing expenses involve the costs incurred to promote the multifamily property and attract potential tenants. This includes advertising campaigns, online listings, signage, brochures, website development, and other marketing efforts aimed at maximizing property visibility and tenant acquisition. It is dependent on each property manager, but NAAHQ has calculated it to be around $200/unit/year for multifamily.
4. Management Fees: Management fees encompass the costs associated with hiring a professional property management company or personnel. These fees cover services such as tenant screening, lease management, rent collection, property inspections, and overall property management. This totals around $600/unit/year in multifamily according to NAAHQ.
5. General and Administrative Costs: General and administrative costs encompass various administrative expenses that are necessary for the operation of the multifamily property and can add up to $350/unit/year. This includes office supplies, software subscriptions, accounting services, legal fees, licensing fees, and other administrative expenses required to ensure the property's smooth operation.
6. Utilities: Utilities expenses encompass the costs of providing essential services such as electricity, gas, water, sewage, and waste management. These expenses vary depending on the property's size, number of units, and usage by tenants, but according to NAAHQ it is around $1300/unit/year for multifamily apartments.
7. Contract Services: Contract services expenses include payments made to external contractors or service providers for specialized tasks such as landscaping, pest control, security services, elevator maintenance, and other services required to maintain the property's functionality and enhance the living experience for tenants. These expenses approximately are $1250/unit/year in multifamily.
8. Insurance: Insurance expenses include premiums paid to insure the property against potential risks, such as property damage, liability claims, and natural disasters. Insurance coverage may vary based on factors like property location, size, and the level of coverage required, but overall NAAHQ reports around $400/unit/year of an expense.
9. Taxes: Taxes consist of property taxes levied by local jurisdictions. These taxes are typically based on the assessed value of the property and contribute to the overall operating expenses. According to NAAHQ’s data, for multifamily buildings the expense can add up to $1750/unit/year.
How can technology help to drive higher revenues in property management?
Lethub enables property managers to reduce operating expenses and provides users with a high return on investment. Lethub automates tasks for property managers as it uses Artificial Intelligence (AI). This AI-powered automation aids in reducing Opex by 10%. Multi-family property managers can save up to $130K a building per year by using Lethub for their property management needs.
Save not only $35K in staff costs but also an agent’s 3 hours per day by getting the return on the tech investment using Lethub. Our NOI calculator also calculates what your Net Operating Income will look like if you use Lethub’s automation for your property management company.