Stop Thinking Rent and Start Thinking Profit & Return

Many owners of single-family rental properties make the mistake of focusing on rent as the barometer of performance and success. They wonder, what is the most I can charge per month, yet still remain competitive? Or, how can I increase my rent and put more money in my pocket without losing my tenant?

Getting the highest rent for your income property is not the best way to build a profitable rental property portfolio. Instead, concentrating on profit and return is a sounder way to shape your rental portfolio’s profit.

The Difference Between Rent and Profit

When you put your emphasis on rent, you’re focusing on the short-term value of your rental property. When you concentrate on profit, you’re focusing on your rental property as a long-term investment. Owners who focus on profit rather than rent are in a better position to build a successful rental property portfolio. This is by far the best method to analyze the true success of your rental property portfolio.

How to Evaluate Profit

Generally speaking, the market for single-family rental homes has never been better. Millennials are postponing purchasing homes and are opting for a more mobile, uncommitted lifestyle. Baby boomers and empty nesters want to downsize and/or are choosing more carefree lifestyles that don’t include owning a home. Other prospects are looking to rent as a way to ride out hard financial times. All of this is very good for rental property owners.

Here are the figures you need to crunch to ensure your rental property is turning a profit:

1.  The monthly rent. This is the monthly amount you are asking tenants to pay. If you are unsure how much rent to ask for, speak with a local property manager or real estate agent. Either one can give you some guidance and some of the better managers will even provide a free market survey to estimate the right amount of rent you should ask for. You don’t want to overvalue the property, make the rent too high and miss out on good tenants. This is often one of the biggest mistakes owners, especially first-time owners, repeatedly make.
2.  Monthly expenses. Calculate all the expenses to pay each month. This includes property taxes, insurance and mortgage (if applicable). Is the rental property part of a homeowner’s association? If so, don’t forget to include the monthly homeowner’s association (HOA) fee. Are you using a property management company? If yes, don’t forget to add the fee to your monthly expenses.
3. Vacancy estimate. While no owner wants their single-family rental home to be vacant, chances are it will be at some time. Budgeting for this each month (at around 5% of the monthly rent) will ensure that you can cover the cost when and if necessary.
4. Repair estimate. You know your property better than anyone. A good home inspection should uncover any blaring issues and give you some warning about what to expect down the road. General guidelines hover around 5 – 25% of the monthly rate, depending on the condition of the home. If you know you’re going to need a new roof or heating system soon, then estimate this figure at the high end. If it’s a new property or has been recently rehabbed, pick a number near the lower end. Don’t underestimate this number. You want to have the cash available when you need it.
5. Net income. You calculate your monthly cash flow by subtracting numbers 2 – 4 (monthly expenses, vacancy estimate and repair estimate) from number 1 (monthly rent) in this list. This is your monthly cash flow and should be in the black.
6. Capitalization (aka cap) rate. This is one of the most commonly used metrics to differentiate a good real estate investment from a bad one. In simple terms, the cap rate is the annual net operating income (NOI) divided by the purchase price. A lower cap rate indicates a lower return due to a perceived lower level of risk, while a higher cap rate implies a higher return due to a higher risk exposure.
7. Cash-on-cash return. This figure is based on cash return from rental properties compared to the cash invested and is a great tool to evaluate and predict the long-term performance of your real estate investment. Cash-on-cash return is the property’s annual net cash flow divided by your net investment and is expressed as a percentage.
   

For instance, if you invested $20,000 into a rental property and it’s returning you $4,000 a year, then your cash-on-cash return is 20%. This is a different calculation from return on investment (ROI) because it doesn’t require you to sell the property. Cash-on-cash returns explain a different story to the real estate investor. To determine your cash-on-cash return, you may consider using one of the many free, online calculators, such as the ones found on Ideal Real Estate Investing or Invest Four More for starters.

Maximize Profit

While raising rent can generate more profit, there are other ways to accomplish the same goal (and not upset tenants). Here are some ways to get the money flowing in the right direction:

Cut costs. When getting estimates for repairs, always get at least three. While saving $10.00 or more might not seem like a lot, small savings can add up over time. Look for big ways to cut costs too. Examine your mortgage rate and any other loans you’re holding to see if there’s a way to lower your interest.

Charge late fees and penalties. While it may not be the most enjoyable part of being an owner, collecting late fees and penalties are essential to running a profitable business. When a tenant signs a lease agreement that includes fees and penalties for late payments, by law that money is yours. Don’t leave money on the table and set a bad precedent by trying to be overly nice.

Lower vacancy rates. Good tenants are worth going the extra mile to keep happy and a smart way to maximize profits. Good tenants pay rent on time and take care of your property so do what you can to please them. Take care of any grievances in a timely and professional manner. Show you care and they will too.

For more ways to increase profit, read our blog article, 5 Tips to Get More Return from Your Rental Real Estate Investments.

Savvy owners know that in order to be successful, you must run numbers on every potential rental property before investing to determine risk and profit. They also know that at the end of the day, numbers are just that—numbers. While determining yearly profit is a fairly straightforward process, it doesn’t take into account the unexpected. Unplanned events like back-to-back evictions, expensive home repairs or fluctuating rental markets can eat away at your profit.

Looking at the profit and cash-on-cash return on your real estate investments rather than worrying about getting the highest rent possible will help you prepare for the unexpected and safeguard your assets.