Return on Investments (ROI) is a very simple but powerful measure. If you take a closer look at it though it can raise plenty of questions. It’s enough to google ROI or check Wikipedia and you will find plenty of spins on the simple ROI formula we looked at yesterday. Today Let’s look at ROI in rental properties.

Things start to complicate when take into account both financial factors (like inflation, taxes) and market/asset related factors (increase/decrease of value, assets wear and tear etc). Additionally the general standard of how to calculate ROI in different markets/countries is also different. Therefore we always advise people to ask their counter-parties what exactly they mean by ROI and how they calculate them. Relying just on numbers without understanding the formula and the context can be risky.

That is also why we also recommend using ROI calculation with caution. For more complex and bigger investments you might want to get help from specialists to get it right. Certainly with bigger capital invested your potential risks of miscalculations grow adequately.

## Return on Investment in rental properties

Given said this we can now show what we use as an ROI formula when we do a quick evaluation of a property offer. Since we look at a number of potential deals often we cannot afford spending too much time on extensive calculation of the ROI as other aspects of a deal due diligence are equally (if not more) important. For us the simple calculation is enough to compare offers between each other.

We use this such formula:

Let’s look at these numbers:

**Annual Cash Flow** — Annual Cash Flow (annual net rent) is the 12 months gross rent (paid by tenants) decreased by all the costs related to this property. That can include management costs (letting agent managing the property), utilities, lending costs (interest on the loan/mortgage that financed that property). It can also include voids — temporary uninhabited flats or rooms). Additionally we include and money we put aside as a maintenance fund — advancing for our future repairs.

**Total cost of the investment **— We used to say ‘money we left in the deal’. It is in other words the money we paid for the house increased by all the expenses we had in relation to acquire the property (taxes, fees, visits to the site etc.). If we financed this property with lenders’ money we deduct the loan from the total cost as the mortgage reduces ‘money left in the deal’.

**Let’s take look at an example:**

Say you purchase a property for £100,000 and spend additional £20,000 on fees, refurbishment and some additional costs. Your total money spent at that point is £120,000. Once property is tenanted, your tenant pays a gross rent of £1,000 every month. Your monthly expenses (management, utilities) are around £300 which gives you a net income from this property of £700.

If you purchased this property with a loan of 75% LTV, your investor (or a bank) lended you £90,000. In such case your total investment cost comes down to **£30,000** (£120,000-£90,000).

Your net income (cash flow) also goes down because of the interest you pay to your lender. So, if your monthly loan costs are £400 your net income goes now to **£300** (£700-£400). Your annual cash flow will then be **£3,000**.

As a result your ROI in such example will be £3,000/£30,000 = 0.1 = **10%**

As you can see in this example we do not take into account two factors. That is inflation and change of value of the property (market depreciation/appreciation). But that is completely fine — if we only use this ROI calculation to compare property deals between each other. In such case this simple calculation is enough.

Happy Investing!