Q&A: What's My ROI on My Rental Property

When evaluating the return on investment of a rental property, you have a few different options on which numbers to use. The numbers depend on what exactly you consider income, and/or what exactly you consider an expense, and what exactly you consider your initial investment.

On the income and expense side, you have the following:

• (+) Rent.
• (-) Principal and interest payment.
• (-) Property taxes.
• (-) Homeowner's insurance. The cost of homeowner's insurance will vary based on location, age of the house, construction type, environmental factors, etc. Mine costs 0.4% of my home value, so I've been using that as a starting point.
• (-) Maintenance costs. For my house, I estimate 1% of my home value in maintenance costs each year. For a rental property, I think I'd estimate 2%. A common rule of thumb is to use 3%, and you can't really go wrong planning conservatively.
• (-) Utilities. This depends on the setup you have for rent - utilities included, a fraction of utilities per room, or utilities in the name of the tenants. In other words, it might not be applicable, but it's not really optional.
• (+ optional) Principal portion of P&I, because it is adding equity to your net worth, but it doesn't help your cash flow.
• (+/- didn't forget about it) Taxes. The interest portion of your P&I isn't directly tax deductible like it is for your primary home, but it is a business expense that offsets your business income. (Your business in this case is being a slum lord.) This applies to all expenses above, plus depreciation of the house, if you go that route. Tax laws concerning business income and losses are somewhat complicated, so I'm not going to go into them.

The net income is fairly straightforward to calculate once you choose what exactly you're including. It's much harder to estimate before you buy the property, unfortunately. Other than the estimates I listed above for insurance and maintenance, many house listings include the previous year's tax amount. Some will also include a history of utility costs, but you usually have to talk to the listing agent and/or current owner. Estimating the rent you can charge requires looking at rooms and/or houses in the area. I use craigslist.org and Google Maps (with the "Real estate" overlay enabled under the "More" button/menu and the Listing type selected as "For rent"). Then, just to be safe, I assume I will rent to college students that move out every summer and leave me with a 25% vacancy rate.

After all that, you find yourself with a net monthly income. You then have to determine how you want to calculate your return on investment. It comes down to whether you consider your initial investment as the amount of cash you parted with - your down payment, or the amount that you're responsible for - the total property value. You can also reevaluate your return on investment at any time using your current equity as your investment amount.

Personally, I'm not a fan of using your current equity to reevaluate. The theory is that as your equity increases, you can increase your ROI by selling the house and using the increased equity to get a new house (or two) with higher income potential. To me, this seems like messing with a good thing. I also hate being in debt, so this might be an entirely emotional position on my part. I also don't view increased equity from home appreciation as an increase in your investment. It's more of an unrealized gain. The only equity I would count is principal reduction, but in that case I would definitely include the principal portion of the P&I as income. The amortization schedule, where the principal portion increases each month, will then take care of the principal reduction to some extent.

Naturally, I made a calculator for this. Utilities aren't included because of the complexity in options. "Maintenance Costs" is a good place to tack that on if you need to. It's fun to play with, if nothing else. I view my maintenance cost and vacancy rate assumptions as conservative. If I can have a positive ROI even with these estimates, I consider it a win. Any extra is a nice bonus. Plus, rent will increase with inflation while P&I should remain constant (until it goes away completely!).

Home Value ($):
Down Payment ($):
Interest Rate (%):
Property Taxes / Year ($):
Homeowner's Insurance / Year ($):
Rent Income / Month ($):
Vacancy Rate (%):
Maintenance Costs / Year ($):
Count Principal as Income?
Yearly ROI?

P&I	Monthly Costs	Monthly Income	Net Income	ROI down payment	ROI total value

New Car On the Horizon

A few days ago, I was driving home on the highway and may car starting making a noise somewhere between a screech and a whine. It was a constant sort of noise, but once I got off the highway, I found that it varied depending on the speed of the wheel - I assume it was once per revolution. It also sounded worse when I applied the brake. I pulled into the gas station, but did not see anything wrong with the wheel right off.

As I continued to drive home, the noise stopped abruptly with a little *plink* sound, and it looked like a washer or something similar was bouncing around behind my car. This was not a comforting development, even though the noise went away.

I took my car in on Monday, and they charged me $50 or so to diagnose the problem. They didn't actually find anything that would result in the noise and missing part that I described, but they found plenty of other problems:

• Air dam deflector - $151.00 - This is apparently a piece of plastic that scoops air into the engine area. I see no reason to spend $151.00 on a piece of plastic.


• Front brake pads and resurface rotors - $180.00 - I knew I needed new brakes soon, but I think they are now likely to find something else wrong with the brake assembly when they get around to putting new ones in.


• Transmission side cover gasket leaks - $274.00 - This one makes me a bit nervous. It evidently isn't leaking horribly, but a leak of transmission fluid is bad. I am clearly an auto maintenance expert, you can tell.


• Rear sway bar links - $244.00 - I knew about this one from awhile back, and they said it wasn't critical. The sway bar distributes load from side to side, so the fact that mine is broken makes my handling worse on turns, and I'm more likely to slide around. It hasn't been a problem yet.


• Left/Rear strut with spring - $531.00 - They skipped this in their haste to go over the list before closing. It's expensive and sounds important. At the moment, I have to plan on fixing it.


• Serpentine belt - $92.00 - The main belt, apparently. They said it has major cracks and they found part of it wrapped around the axle, so it's already falling apart. This is the most pressing issue.


• Muffler strap - $99.00 - This is just a simple bracket that helps hold the muffler on. There is no reason this should cost $99.00, and I refuse to fix it.

All told, the things that aren't completely trivial would cost $1321 to fix. I also need an oil change soon. Thus, I entered into a cost analysis to see if getting a new car was a better investment than continued maintenance.

Car:	Civic	Corolla	Focus	Prius
Price1:	18225	16750	15995	22000
Monthly cost2,5:	$285.94	$255.21	$239.48	$364.58
Monthly Insurance3:	$25.5	$26.00	$24.83	$21.83
Monthly Total:	$311.44	$281.21	$264.31	$386.42
Months to recoup4,5:	18.69	20.69	22.02	15.06

1. Price is base price of a model, not including any packages. I don't need any packages or options, but dealers rarely have plain cars in stock, so this price will probably be an underestimate. It also doesn't include fees, taxes, charges, whathaveyou.


2. Monthly cost is based on a 48-month 0% loan. I probably can't get that rate at the moment, but it also doesn't account for any down payment or trade-in money, and so shouldn't be too terribly far off.


3. Monthly insurance is the cost to insure the new vehicle minus my current monthly rate on my old car.


4. Months to recoup is how long I would have to keep driving my current car to make the repairs worthwhile.


5. Figures reflect a $4500 price reduction corresponding to a CARS trade-in (my family has an old van that is rapidly dying). This represents an opportunity cost associated with repairing my current vehicle as opposed to buying a new one.

At this point, I find it unlikely that I can drive my car for another year or two without the need for further repairs. The bonus of a $4500 price reduction makes getting a new car very practical!

UPDATE (08.22.2009-1019): It would appear that we cannot get into the safe deposit box that contains our car titles, so there can be no trade-ins. With the $4500 bonus out of the picture, the recoup time becomes just 2-4 months, making the repairs far more practical. No new car for me!