Return on investment (ROI) is the ultimate scorecard for rental property investing. It tells you whether your investment is performing well—and lets you compare real estate to stocks, bonds, or other opportunities.

But rental property ROI isn't as simple as stock returns. Real estate generates returns in multiple ways, and how you calculate ROI depends on which components you include.

What is ROI?

At its simplest, ROI measures the return you receive relative to your investment:

ROI = (Gain from Investment - Cost of Investment) ÷ Cost of Investment × 100

For a rental property, both "gain" and "cost" have multiple components, which is where things get interesting.

The Four Components of Rental Property Returns

1. Cash Flow

Monthly rental income minus all expenses (mortgage, taxes, insurance, maintenance, vacancy, management). This is the money in your pocket each month.

2. Appreciation

The increase in property value over time. You don't realize this gain until you sell or refinance, but it's often the largest component of total return.

3. Principal Paydown

Each mortgage payment includes principal that reduces your loan balance. Your tenants are essentially buying equity in the property for you.

4. Tax Benefits

Depreciation deductions reduce your taxable income, often creating "paper losses" even when you're cash-flow positive. Tax savings improve your after-tax returns.

A complete ROI calculation should include all four. But different ROI formulas capture different combinations—and that's okay, as long as you know what you're measuring.

Cash-on-Cash ROI (Simplest Method)

This is the most commonly used ROI calculation for rental properties. It measures your annual cash return relative to cash invested.

Cash-on-Cash ROI = Annual Cash Flow ÷ Total Cash Invested × 100

Example:

• Purchase price: $300,000
• Down payment (20%): $60,000
• Closing costs: $6,000
• Initial repairs: $4,000
• Total cash invested: $70,000

• Annual rental income: $28,800
• Annual expenses (taxes, insurance, maintenance, management): $9,600
• Annual mortgage payments: $14,400
• Annual cash flow: $4,800

Cash-on-Cash ROI = $4,800 ÷ $70,000 = 6.9%

This tells you that your cash investment is returning 6.9% annually in spendable income.

Pros: Simple, intuitive, focuses on actual cash returns

Cons: Ignores appreciation, principal paydown, and tax benefits

Total ROI (Including Appreciation)

To capture appreciation, calculate the total value gained (not just cash flow) divided by your investment.

Total ROI = (Cash Flow + Appreciation + Principal Paydown) ÷ Total Cash Invested × 100

Example (continuing from above):

After one year:

• Cash flow: $4,800
• Property appreciated 3%: $300,000 × 3% = $9,000
• Principal paid down: $3,200 (check your amortization schedule)
• Total gain: $17,000

Total ROI = $17,000 ÷ $70,000 = 24.3%

The total return picture looks much better than cash flow alone. This is why many investors accept low cash-on-cash returns in appreciating markets—they're earning the rest through equity growth.

Pros: More complete picture of investment performance

Cons: Appreciation is unrealized (and uncertain), can create false confidence

Annualized ROI

For investments held longer than one year, you need to annualize returns to compare them fairly.

Annualized ROI = [(Ending Value / Beginning Investment)^(1/years) - 1] × 100

Example:

You bought a property 5 years ago:

• Total cash invested: $70,000
• Total cash flow received: $25,000
• Property increased in value: $45,000
• Principal paid down: $18,000
• Total return: $88,000

Total value now: $70,000 + $88,000 = $158,000

Annualized ROI = [($158,000 / $70,000)^(1/5) - 1] × 100

Annualized ROI = [2.26^0.2 - 1] × 100 = 17.7%

This tells you that your investment has grown at an average rate of 17.7% per year.

A Step-by-Step ROI Calculation

Let's work through a complete example:

Purchase:

• Price: $400,000
• Down payment (25%): $100,000
• Closing costs: $10,000
• Renovations: $15,000
• Total cash invested: $125,000

Loan:

• Amount: $300,000
• Rate: 6.5%
• Term: 30 years
• Monthly payment: $1,896
• Annual payment: $22,752
• Year 1 principal paydown: $4,650

Income:

• Monthly rent: $3,200
• Annual gross rent: $38,400
• Vacancy (5%): -$1,920
• Effective gross income: $36,480

Operating Expenses:

• Property taxes: $4,800
• Insurance: $2,000
• Maintenance (8%): $3,072
• Property management (8%): $2,918
• CapEx reserves (5%): $1,920
• Total expenses: $14,710

Cash Flow:

• NOI: $36,480 - $14,710 = $21,770
• Less mortgage: -$22,752
• Annual cash flow: -$982

Wait—negative cash flow? At current rates, yes. Let's see the full picture:

Year 1 Returns:

ROI Calculations:

• Cash-on-Cash ROI: -$982 ÷ $125,000 = -0.8%
• Total ROI (Year 1): $15,668 ÷ $125,000 = 12.5%

This property has negative cash flow but a 12.5% total return when you include equity building. Whether that's acceptable depends on your goals—cash flow investors would pass; appreciation investors might find it attractive.

What's a Good ROI for Rental Property?

Rules of thumb:

• Cash-on-Cash: 8-12% is generally considered good; 15%+ is excellent
• Total ROI: 12-20% is solid for leveraged real estate
• Minimum threshold: Beat what you'd earn in passive investments (currently ~5% for high-yield savings, historically ~10% for S&P 500)

Remember: real estate requires active management, carries illiquidity risk, and concentrates your capital. It should offer a premium over passive alternatives.

Key Takeaways

• Cash-on-Cash ROI = Annual Cash Flow ÷ Cash Invested
• Total ROI includes cash flow, appreciation, principal paydown, and tax benefits
• Annualize returns to compare investments over different time periods
• Negative cash flow doesn't always mean bad investment—check total returns
• Use consistent metrics when comparing multiple properties
• Target ROI should beat passive alternatives plus a premium for active management

ROI is how you keep score in real estate investing. Know which version you're calculating, understand what it does and doesn't include, and use it to make better investment decisions.