Rental real estate properties has always been a good way to make money and build wealth. As a landlord, you need to know how to calculate your rate of return on a rental property to determine if it will be effective as an investment.

Real estate investors understand the importance of the return on investment (ROI) . However, it can be challenging to figure out the correct ROI calculation, as they can be easy to manipulate. Also, real estate investors have the option of paying cash or taking out a mortgage on the property; therefore, some variables can be either included or excluded when making the calculation. Let’s take a look at some methods for calculating the rate of return on a rental property.

**ROI for Rental Property Calculation: Simple Formula**

Most real estate investors should know the simple rate of return formula, which is: **ROI = (Gain from Investment – Cost of Investment)/Cost of Investment**

For example, if you invested $50,000 in an investment property, and the total profits you made from your investment add up to $70,000. In this example, the rate of return on your investment is: ROI = ($70,000 – $50,000)/$50,000 = 0.4 = 40%

Remember, this is the simple rate of return on investment formula, and as you can see, it is incredibly general and includes a many estimates along with unproven numbers. Different methods used to determine the rate of return on a rental property are mainly the cap rate and the cash on cash return. You can determine which one to use depending on how you paid for your property.

**ROI on a Rental Property** **Calculation: Cap Rate Calculation**

Real estate investors use the capitalization rate (cap rate) when they pay for the rental property in cash. It is used to measure the profitability of an investment property, and is commonly used to compare similar real estate investments.

Cap rate is defined as the ratio between a property’s net operating income (NOI = Rental Income – Operating Expenses) and the purchase price. The formula for calculating the cap rate is: **Cap Rate = NOI/Purchase Price × 100%**

The cap rate calculation is pretty easy. If you bought a rental property and paid $200,000 in cash, $2,000 in closing costs, and $18,000 for remodeling, which makes your total investment in the rental property $220,000. If your tenants pay $1,600 for rent every month, that means you’ve gained $19,200 for the year. Now, to be more realistic, we’ll deduct from that a cash flow of $4,000 per year to cover other expenses that you can’t avoid such as property taxes, property insurance, maintenance, property management, etc. Thus, your annual return would be $15,200.

Now, to calculate the rental property’s ROI, follow the previous cap rate formula and divide the annual return ($15,200) by the total investment you initially made ($220,000). Cap Rate = ($15,200/$220,000) x 100% = 6.9%. This means that your rental property’s rate of return is 6.9%.

**What Is a Good Rate of Return?**

When calculating your ROI on a rental property you should use the cap rate calculation. Today, most real estate experts agree that a good ROI is typically around 10%, and a great one is 12% or more. Contrarily, when using the cash on cash return calculation some experts will disagree on what is considered a good ROI. Some say that to be in the range 8-12% is okay, and some others won’t even think about investing in a rental property if it doesn’t guarantee them 20% return on investment.