There’s a Brand New Metric to Track the True Success of Your Real Estate Deals

It’s almost time for The House Hacking Strategy, and we couldn’t be more excited! This stellar book digs deep into the BiggerPockets phenomenon we like to call “house hacking”—a real estate investing strategy that’s all about lowering your living expenses, building equity, and taking that first big leap toward financial freedom.

At only age 26, author Craig Curelop owns three cash-flowing properties that he acquired through the house hacking method. He’s also a financially free frugality master: besides sleeping on a futon in his living room while renting out his bedroom for a year, he also rented out his car, chooses to bike everywhere to save on gas, and loves travel points more than life itself.

Related: What’s a Better Financial Strategy—Making More or Spending Less?

In this book, you’ll learn what house hacking is, why it’s one of the best methods for building wealth, and exactly how to make your first (or next) house hack a success. It covers every step of the process—getting started, finding your perfect property, tackling property management, and more—alongside real-life stories from house hackers all over the country.

It also introduces a brand new metric that helps track the true success of your house hacking deals. You can use this equation both to analyze future deals and to look back at the success of past deals. Here’s an exclusive sneak peek from Chapter 7.

Net Worth Return on Investment (NWROI)

Your net worth return on investment (NWROI), similar to a cash-on-cash return, summarizes exactly how good an investment will be (or has been) through a percentage. The higher the percentage, the better the deal. Unlike cash-on-cash return, NWROI takes into account all wealth generators of real estate: cash flow, appreciation, and loan paydown; and it shows the overall impact it has on your net worth. We are going to ignore tax advantages because it is different for everyone, but keep it in the back of your mind that every NWROI mentioned throughout this book will be slightly understated for this reason.

The NWROI can be forward-looking when analyzing and predicting how good a deal will be for you. It can also be backward-looking when determining how good the deal actually was for you. Either way, to calculate the NWROI, you are going to add together your increased net worth through: cash flow/rent savings, loan paydown, and appreciation. When you get that sum, you will divide it by your total initial investment to determine your net worth return on investment. The initial investment is any cash coming out of your pocket to initially secure the deal. Examples may be the down payment, closing costs, and rehab costs. In a formula, it looks like this:

NWROI = (cash flow and rent savings + loan paydown + appreciation) / initial investment

Let’s use my first property as an example of how to calculate the NWROI. I purchased my first house hack for $385,000. It was a newly renovated, up/down duplex with each unit having one bedroom and one bathroom. I did a 3.5 percent down FHA loan. After the down payment and closing costs, I was all in for $17,000.

Cash flow/rent savings = x 

Loan paydown = x 

Appreciation = x

Initial investment = $17,000

There are many ways to generate wealth, but the first is cash flow. My strategy with the duplex was to rent out the top unit full time and Airbnb my bedroom while I slept in the living room. The top unit made me $1,750 per month and the bedroom generated about $1,100 per month on Airbnb. My total rental income was $2,850 while my entire mortgage payment (PITI and PMI) was $2,000. Because it was a new build and in a great location, I set aside $250 for reserves each month.

My monthly cash flow: $2,850 – $2,000 – $250 = $600 per month

It does not stop there, though. I was also paying nothing to live there. My rental expense was zero dollars and I was making $600 per month. Understand, though, that I was sleeping on a futon behind a curtain in the living room so it would not be a long-term situation. However, if I had not house hacked, but had the same living situation, I estimate that I would have paid approximately $400 in rent. My cash flow and rent savings was $600 plus $400, or $1,000 per month. Because we are looking at net worth return on investment after the first year, we will multiply this $1,000 by twelve to make it an annual number.

Monthly cash flow and rent savings = $600 cash flow + $400 rent savings = $1,000 

Annualized cash flow/rent savings = $12,000 

Loan paydown = x

Appreciation = x

Initial investment = $17,000

Next, let’s talk about the loan paydown as it relates to the NWROI.

A portion of your monthly payment is principal. That is the “P” in PITI. Principal is the balance you owe the bank. As you pay a portion of the balance each month, the principal reduces, which lowers your loan amount and thereby increases your net worth. I started off with a $378,000 loan and at the end of one year had paid it down to about $370,000. In other words, after one year the loan paydown increased my net worth by $8,000.

Monthly cash flow and rent savings = $600 cash flow + $400 rent savings = $1,000

Annualized cash flow/rent savings = $12,000 

Loan paydown = $8,000

Appreciation = x

Initial investment = $17,000

Last but not least is appreciation. Appreciation is where you take the most risk, but you also get the most reward. There are two types of appreciation. There is natural appreciation, which is the steady 6 percent you expect real estate to increase year after year from doing nothing. But you never bank solely on natural appreciation. Instead, find a nice cash-flowing property in an area that has a high likelihood of appreciating, or a property where you can force the appreciation.

Forced appreciation is when you increase the value of the property by improving it yourself. This can be by adding bedrooms or bathrooms, square footage to the house, an ADU, or just cosmetic enhancements such as new cabinets or floors.

The duplex I purchased was fully remodeled so there was no forced appreciation to be realized, only natural appreciation. Luckily, the Denver market did improve from 2017 to 2018, and it was worth approximately $435,000 one year after I purchased the property. (Remember, I bought the property for $385,000.)

The impact on my net worth from appreciation was $50,000. 

Monthly cash flow and rent savings = $600 cash flow + $400 rent savings = $1,000

Annualized cash flow/rent savings = $12,000 

Loan paydown = $8,000

Appreciation = $50,000 

Initial investment = $17,000

Now that we have all of the pieces to the equation, we can enter them in and calculate my net worth return on investment. If we add up all of the ways I generated wealth in my first year, we would get $70,000. Divide that by $17,000 and you get a return of 412 percent.

NWROI = ($12,000 + $8,000 + $50,000) / $17,000 = 412%

A 412 percent return sounds crazy right? It’s not! You’ve already seen from the case studies how house hacking can build your wealth. The main reason why you can achieve these high returns can be attributed to the fact that initial investment is incredibly low relative to what you can make on the returns.

The example I gave was a backwards-looking example, and it illustrates just how good my deal was after the first year. As I’m sure you noticed, the factor that propelled my return was appreciation. This will likely be the case for you, too. However, appreciation is speculative, especially natural appreciation. When using the NWROI to analyze and predict the outcome of a deal, I would highly suggest being conservative and using zero percent as your appreciation assumption.

Let’s return to the example of my duplex. This time let’s calculate the NWROI as if I was still analyzing the deal. Since I do not know what the market is going to do over the next year, and I was not planning on making any renovations, I am going to assume that appreciation is zero percent. Let’s run the numbers back through the equation:

NWROI = ($12,000 cash flow + $8,000 loan paydown + $0 appreciation) / $17,000 initial investment = 118%

Before knowing what the market will do over the next year and without taking into account any tax advantages, I knew that I would see a return of 118 percent. This is still a better return than almost any other investment option.

To summarize, your net worth return on investment is an important metric that can be used to evaluate the health of your deal as it relates to your personal wealth. It is a rather simple calculation, which is why I like it! You sum up all of the wealth generators of real estate and then divide it by your initial investment. 

Here is the formula one more time:

NWROI = (cash flow and rent savings + loan paydown + appreciation) / initial investment

Are you considering house hacking? Or have you already house hacked? What was your NWROI?

Share in the comment section below! 

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.