The Real Return on My Rental Property

I have been renting my 1st home for just over a year and now have 12 months of data to look at. Lets see how this investment is fairing. I purchased this property for $160,000 in 2002, lived in it for 3 years and began renting in 2005 for $1200/mo.

My first challenge is to establish what the investment amount is so we can calculate a rate of return. The wrinkle is I lived in the house for 3 years before I started renting it out. How should I calculate my investment amount?

I ended up using this formula [purchase price]-[current mortgage balance] = [Current Equity] for the investment plus I added any capital improvements or personal property I purchased for the property. Here is what I used to establish my investment amount:

Rental Investment as of 8/1/2005

Equity @ Conversion


Closing Costs

$ 4,175.00

New AC

$ 1,548.00

Bathroom Remodel

$ 3,579.00


$ 1,473.00



Note: While I think this will help us get a close approximation of my rate of return - its not exact. For example it doesn't factor in my usuage of the new AC system, or bathroom remodel - they probably were not worth what I put into them since I used them before I converted the property. I also calculate my equity using the purchase price of the property and I suspect the property has probably appreciated since I purchased it.

Here is the rental income from Aug 1, 2005-July 31, 2006:

Rental Income


$ 1,200.00


$ 1,200.00


$ 1,200.00


$ 1,200.00


$ 1,200.00


$ 1,200.00


$ 1,200.00


$ 1,200.00


$ 1,200.00


$ 1,200.00


$ 1,200.00


$ 1,200.00



Here are my cash outflows for maintenance, repairs, and other misc expenses:

Date Range

Misc Expenses

Aug 1,2005-Dec 31, 2005

$ 814.89

Jan 1, 2006-July 31, 2006

$ 185.61


$ 1,000.50

This leaves the equity change and remaining cash to count as profit. I calculate equity change by determining how much mortgage principal was paid during the year :

Date Range

Equity Change

Cash Retained

Aug 1,2005-Dec 31, 2005

$ 875.42

$ 395.96

Jan 1, 2006-July 31, 2006

$ 1,260.49

$ 1,368.56


$ 2,135.91

$ 1,764.52

If I use $50,552 as my investment on Aug 1, 2005, and assume a profit of $3,900 by July 31, 2006 - I get a rate of return of 7.72% for this 1st year. Wow!

That is an awesome return when you realize 1) tax benefits (if any) haven't been factored in, and 2) the appreciation of the property over the time period has been ignored.

However, this is probably an optimistic return as
1) the property surely appreciated between the time I purchased it and subsequently converted it to a rental.
2) I managed the property myself - this would easy consume 5-8% of the income just for the management fees.
3) I did as many of the repairs as possible - I only called an AC repair-person when I couldn't fix it myself. Calling service technicians out instead of repairing it myself would add significant costs.
4) my rental property was continually occupied. The tenants renewed their lease so I was lucky enough not to have any costs trying to repair and/or rerent the property.
5) I didn't factor in my startup conversion costs such as cleaning, landscaping, vacancy etc. that occurred before August 1st when the tenants moved in.

Nonetheless this is a fantastic return for me. As with all leveraged rental property with a higher rate of return than the mortgage interest rate, this return will probably slightly decrease each year as my equity builds in the property. That means this investment return is probably as good as it gets with the least amount of equity tied up and my expenses below normal.

Performing this calculation mid-year is challenging as I can't accurately calculate my tax benefit - I plan to recalculate my entire 2006 return in January and could then include the tax benefits.

Here is my 2005 performance analysis of the rental property.

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Rental Property Investment Breakdown (Sep 27, 2011) Here is some overdue financial record keeping from our latest rental investment in August 2011. This breaks down all our out of pocket costs to purchase the property and get the 1st tenant in place. Out of Pocket Investment in...

Comments (17)

That's awesome, the increase in equity in the home could potentially be viewed as profit since you weren't the one who had to pay the money. Once you decide to sell the property then you've gained additional money.

Rental properties have always been an investment vehicle that I've been interested in. Great to hear such a success story.

What about property tax? Where does that expense fit into your equations?

Good question - I forgot to mention that insurance and property taxes are held in escrow as part of my monthly mortgage payments. So they are factored into this even though I didn't provide a breakdown of the money that went towards mortgage payments.

The net is the Cash Retained is the amount of rent after mortgage payments and the rest of my expenses.

That's some good financial book keeping there. I have a rental property that I'm not currently making a gain on. I ended up paying about 40% more for the home and get only about 15% in rent. It's good to see these numbers as it gives me justification to raise the rent a bit next year.

That is a great return! DH and I are thinking about moving south and turning some of our poughkeepsie home equity into a home and a rental in SC. I do like the way that you have done your analysis. Who is keeping an eye on the place for you while you are away?

Try telling your story on the housing bubble blogs! But, it's true and real experience.
Now, multiply that by many many properties and you see why it's a plan for great wealth.
Good job. Just two important points:
1. since you lived in the house first, once it passes 3 years as a rental you have lost your $500,000 exclusion in case you were planning to sell.
2. As a rental, consider buying a Home Warranty plan for $305 from Old Republic.

Very nice! An upside to your ROI is the fact that this is a converted primary home to investment property. You benefited by being able to finance the property as a primary home - which means you likely have a lower interest rate on your mortgage than if you had gone into this as a strict investment purchase.

As for the loss of the capital gain exclusion ($250,000 for single and $500,000 for married) that is a downside (if you keep renting for more than 3 years) or you can try going around that by doing a 1031 exchange or reconverting back from rental to primary home...

Jane Dough - good point - I have a couple friends that have purchase rental property in the last year or so but they only had to pay roughly a .25% higher than current primary rates. I think the advantage of converting from primary to rental is diminishing.

I don't anticipate selling this property for a very long time. Why would I - its getting a decent return and if I sold it in the next few years my capital gains would only be in the $20-$50k range (ballpark in my estimated opinion). To me this is a 20-30yr investment.

2mil - I hate to be a downer, but I have a couple observations.

1) Isn't it illegal to carry a 'primary residence' mortgage on a property that isn't a primary residence? Shouldn't you refinance into an investment loan? This almost sounds like mortgage fraud. As you mentioned, the interest rate might not change much, but the amortization period would probably shorten, killing monthly cash flow.

2)I'm not sure that the 7.72% return is much to rave about. For one thing, the S&P 500 jumped by 13% during the time period. Also, you were very fortunate (lucky?) to have no vacancy loss. Even two month's vacancy and a few dollars of advertising/cleanup costs would eliminate nearly all of your profit. As you mentioned, the property has most likely appreciated, but it is likely that the appreciation occurred prior to 8/1/05 when it was converted to a rental. In all, this rental income seems to be operating on a razor-thin margin (ie. a little vacancy will render it unprofitable), and I'm not sure that a best-case 7.72% is nearly enough to pull me away from the risk-free 5% that cash/CDs are yielding right now.

Fair observations....

1) My understanding is the only requirement in my loan agreement is that the property must serve as my primary residence for 1 year after signing the mortgage. Even so I am not particularly concerned about it as I know of many people that do the same thing.

2) I disagree - I think 7.72% is something to get at least a little excited about. I am not saying someone can't do better, but getting a 7.72% return on a real estate investment while ignoring tax benefits and appreciation is a very profitable investment to me.

Heres why. Even if the rental only return 5% vs a 5% return in a cd I still think its a much better investment than a CD because of the leveraged appreciation.

Lets assume I hold the property for 30 years (I am planning on holding forever). Over the 30years I think its very safe to say the property will easily appreciate 2%/yr (being ultra conservative). If the house is worth $160,000 then that is a $3,200 return the 1st year and slightly more each year after. Add that to the $3,900 return I recognize already and I am now at ~14% return still ignoring tax benefits.

2mil -

1) Regarding the primary residence clause - good job on reading the fine print, and benefitting from the longer amortization and lower interest rate. I have to admit I haven't read my own mortgage that closely.

2) Don't get me wrong - I feel that real estate, if financed and managed properly, can be a tremendous asset over time. I am just very cautious right now, because real estate asset prices seem high, and the cap rates seem to not reflect the risk and hassel of owning real estate. For example, I would assume that over time your house will sit empty 10% of the time (at least 1.5 months every year, on average). This will cost you about $2000 per year, on average. Also, I would expect that repairs and maintenance will eat up about 2% of the cost of the house every year. For example, you will have to put a new $10,000 roof on every 10 to 15 years, replace water heaters, furnaces, A/C, etc, as well as perform occasional extensive cosmetic repairs after a problem tenant moves out. Also, that appreciation doesn't come without a cost; I would expect taxes and insurance to rise in lockstep. In my analysis, in the current real estate market, it is very likely that the repairs/taxes/insurance/vacancy can destroy the fragile cash flow and appreciation, and that 2% over risk-free doesn't make sense to me. I guess it's a difference of opinion and preference.

Anyway... like I said earlier, I don't mean to be a downer. I'm glad you're pleased with your real estate investment. By the way, I really enjoy your blog, and appreciate all the responses you have for reader posts.

CPA - Well put. You bring up all very valid concerns. And this could very well be a poor investment if any of those come to fruition.

Let me share some of my ideas to mitigate them. I think the vacancy rate will consistently be about 1 week per year - why? My house is in a university area - and I am renting it to graduate students. They are all on the same schedule so as one tenant is ready to move out the next is moving in - as long as I don't have to evict I should have below average vacancy.

I expect the taxes and insurance increases to be more than offset by rent increases.

Repairs to HVAC, roof and other major items are a concern. However, I enjoy doing repairs myself which will help minimize cash outlays for repairs.

Its only year 1 - check back in 20 years and we can see how Im doing ;-).

2mil - if you promise to keep blogging for 20 years, I'll promise to keep reading.

I didn't realize the house was in a college town. That should definately help with vacancy. And, it's good that you're handy and can take care of repairs. Many of us aren't so lucky. One of my biggest financial regrets is not taking money out of the stock market in 1999/2000 and buying a small house in the town in which I was attending college. I had enough for a solid downpayment, and could've rented to a roomate to cover most of the payment. Plus, real estate took off during my stay (I was in school from fall of 1998 to fall of 2003). Also, it would've been a nice jump start to my ramping up my FICO.

Hey 2mil,

I was curious if you looked into the details of renting out the property if you from NC. Are you going to have someone manage the property? Have you looked into the fees associated with being a long distance landlord?



Good question. I am actually facing a bit of that issue now since I am on a temporary assignment in NY till the end of the year. If I leave the area and keep the property I would have to have someone manage the property - I have already learned from my current experience in NY that I need somone close by to deal with issues.

If I leave the area I think I would have to make an assessment of the rental returns to see if it would still be reasonably profitable if had someone manage it for me. I suspect if I move, there is a good reason (ie I job promotion or something) and I would be factoring into the cost of the move the extra rental management expenses.

Wow! I just clicked back to this post that you had linked to in today's blogpost and saw that I had commented about moving south and buying a home and a rental back in late 2006! We did do exactly that- moved in 7/07 and bought a rental in 1/08! pretty cool.

When you plan to spend time living in your rental properties, the numbers can change considerably from properties you only plan to rent.

When you live in the property, you have more cushion because, under many circumstances, if things don't go quite as planned, you can just hang tight for longer than planned.

I think rental properties are a great way to generate wealth but, as we've seen in recent years, it can also take everything you own when you don't do it just right.

Anyway, glad to hear things worked well for you!

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A personal finance weblog of my journey to reach my goal of $2 million + the value of my primary residence.
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