How to Accurately Estimate ROI

[Brianna H.]

Am I the only one that doesn't feel like the ROI calculations are good enough? I have expenses that come up at different times of the year (taxes, insurance, etc) and then I am saving for capex, random repairs, etc.

My current strategy for determining ROI is to use the following formula:

principal paydown / initial investment

I feel like this strategy is more conservative, but still not very accurate. Does anyone else use an alternative way to calculate ROI? Maybe I should be calculating ROI on a monthly basis and taking my average? Thoughts?

[J Scott]

Originally posted by @Account Closed:

Please answer my question in the earlier post.

Here is the answer to the question you asked about how capex is related to NOI:

"Technically, capex doesn't factor into NOI...it's considered "below the line" in the calculations."

I've now written that three times.  Including before you even joined the thread.  Remember, you quoted it and repeated it back as if you had thought of it.

If you believe that statement is incorrect, I'm happy to discuss further.  If not, you're just hijacking this thread like you seem to do with every other thread.

[Account Closed]

Originally posted by @J Scott:

Originally posted by @Account Closed:

Please answer my question in the earlier post.

Here is the answer to the question you asked about how capex is related to NOI:

"Technically, capex doesn't factor into NOI...it's considered "below the line" in the calculations."

I've now written that three times.  Including before you even joined the thread.  Remember, you quoted it and repeated it back as if you had thought of it.

If you believe that statement is incorrect, I'm happy to discuss further.  If not, you're just hijacking this thread like you seem to do with every other thread.

 You seemed to miss this post of mine,

Originally posted by @J Scott:

J don't get too excited! In fairness I included your "technical" statement but really am addressing the above. I prefer to educate than argue. I thought that was what this forum is about. Do you want to argue the above or will you join me educating?

This is ALSO what you said that you seemed to agree was incorrect, 

"nobody is going to fault you for factoring it into the NOI calculation"

Now please STOP attacking me and trying to make this personal.  Please support your accusation that, 

"you're just hijacking this thread like you seem to do with every other thread."

You are losing creditability by your continued lack of support for your assertions and your attacks on me.  Did you ever consider that is the reason your threads and posts are being deleted?

[Account Closed]

Originally posted by @Cal C.:

awesome it's been a while since the bob and jay so has been on.  Pass the popcorn!

Geez, cut and paste quick cause this will be deleted soon.  I'm willing to put up with the personal attacks because there actually is some good info here and perhaps stimulates some critical thinking.

[Account Closed]

Originally posted by @Cal C.:

awesome 

[Ben Leybovich]

IRR covers all of this. IRR tracks all of the inflows and outflows of cash, and you can count both forced and organic equity appreciation as positive CF events, presuming you have a strategy in place relative to liquefying. Accelerated principle pay-downs are simply re-investment of CF, and are simply negative cash flow events vs. positive equity appreciation event.

IRR presumes re-investment of cash flow at the IRR rate, which is why some people don't like it, since we take cash flow out and live on it, and in many cases it is not reasonable to re-invest at the same exact rate. In this case, if this bothers you, you can run MIRR (modified IRR) and elect any discount rate you like and/or deem reasonable.

Finally, and this is huge, as @J Scott mentioned, the IRR requires you to plot out all of your cash flows (including the exit) before they actually happen. For this reason, folks don't think IRR is "real". But, in my view it is the most robust and viable precisely because it forces us to think through what the cash flows might look in the future and why, and what our exit might look like, and why ? Shouldn't we do this as intelligent investors?

Now - is it really necessary to go this in-depth on a duplex...probably not. But, you asked :)

[Jacob Sampson]

You've been given good advice regarding your question. I would just add a tweak to the way in which you calculate the performance of your buy and hold real estate. Here is an example of why you need to calculate it slightly different. If you purchase a $100k home with 20% down and 5k is other costs then you have $25,000 invested. If after all expenses you clear $2500 cash flow in a year then you have a 10% ROI. If everything stays exactly the same then 15-30 years later you owe nothing on the house and are still clearing the same $2500 a year in cash flow. You are not still getting a 10% ROI because your principle payment is your cash that you have chosen to invest in that property (forced by bank or not) you could refi that cash out to invest elsewhere are you could sell and invest the cash in something else.

For buy and hold RE you should use return on equity (ROE), that is value of the property minus the amount owed.  If there is significant cash invested in closing costs and fees you will want to add that in.  Generally, unless I am absolutely certain that my property has appreciated, I don't bother including appreciation in the calculation.  I use my purchase price as the actual value.

In the example above where the property is paid off you would only be getting a 2.5% return on equity.  Assuming rents increase as fast as you buy principle down then you continue to do well.  In my case I only do 10-15 years loans so i usually pay principle down faster than rents increase.  Thus, my ROE slowly gets worse and worse and once I drop below 10% ROE that is my signal to re leverage my equity, to keep it working hard for me.

This feels long winded and possibly not all that intelligable. if so, I apologize and just ignore it. Long story short, add principle payment into the amount you have invested when calculating ROI, because that is your money.

[Bill Gulley]

"Accurately" and "estimate" should not be used in the same sentence.

Real estate is not a stock or a bond, while financial ratio analysis has a place, it isn't that applicable to real estate, attempting to estimate ROI or ROE less than annually for small investors is really wasting time playing with your calculator. These are historic performance indicators, guessing what day you'll replace a roof isn't a valid approach, neither is saying what week a tenant will walk off.

Real estate isn't an assembly line, it is not a statistically valid process, it is not a liquid asset or market. Risks are unlike other investments, you can't compare cattle futures to a residential leased property except historically to say which would have been the better investment. 

Real estate basics 101, chapter one, real estate is unique unlike other assets. Risk is a function of economic return, if an asset is unique it can'r really be compared to another asset in a liquid and more volatile market on an equal footing. The compensating factor is the capitalization rate as it requires that different risk factors be applied. 

One risk is the requirement to invest or expense funds to maintain the financial and economic value of real property, this can come from acts of God, storm damage, while your T-Bill is not effected. 

Because real estate is in a less volatile market, real estate is a long term asset, value is gained or lost over time, in years generally, not in a month unless you force appreciation by improvements. 

Your investment strategy or operation will determine what ratio might be applicable, a flipper is improving a property over a short period of time, ROI is more applicable to them than it is to a landlord holding for 7 years, who looks more to cash on cash.

Cash on cash is applicable to all strategies, it is rather meaningless to someone who sells as a broker or wholesaler, there is very little investment made and such operations are not investing but operating with an investment of intrinsic values, time, knowledge, expertise and marketing. 

ROI and ROE are more applicable to the measurement of financial performance of your company, taking into consideration all necessary expenses and income, you're looking at the company's performance, what the company does is irrelevant. These ratios are applicable to a portfolio of investments, the assets held are again, irrelevant.

But, when you target a specific asset, you need to be more specific as to the type of asset, costs of management, holding, selling and associated risks. Crunching numbers and getting an indication of a return at 12% is meaningless unless you can compare that 12% to similar investments. Owning one rental and saying you should have or had a 12% return doesn't fully address the reason we use financial ratios. Another reason cash on cash is more applicable.

Another point as to holding one or even several properties, your expenses, time and cost of management, alternative investments or income will never be what the past owner achieved nor will it be the same for any owner year to year. No two properties will be the same either, why, because real estate is unique unlike any other asset on the face of the earth. 

Historically, ROI or ROE can measure the performance of one property to past years or accounting periods, it may be higher or lower, than previous periods. What good is that in reality when you already know you lost three months of rents and had to put on a new roof. Even after you adjust for the capitalization, taxes and management, what does that ROI really tell you? Not anything you can bank on. Cash on cash tells you if you're making money.

You'll use your time much better understanding the economics of real estate than wasting it on forecasting future returns, money is made by applying economic principles to real estate. :)    

[Brianna H.]

Originally posted by @Jacob Sampson:

You've been given good advice regarding your question. I would just add a tweak to the way in which you calculate the performance of your buy and hold real estate. Here is an example of why you need to calculate it slightly different. If you purchase a $100k home with 20% down and 5k is other costs then you have $25,000 invested. If after all expenses you clear $2500 cash flow in a year then you have a 10% ROI. If everything stays exactly the same then 15-30 years later you owe nothing on the house and are still clearing the same $2500 a year in cash flow. You are not still getting a 10% ROI because your principle payment is your cash that you have chosen to invest in that property (forced by bank or not) you could refi that cash out to invest elsewhere are you could sell and invest the cash in something else.

For buy and hold RE you should use return on equity (ROE), that is value of the property minus the amount owed.  If there is significant cash invested in closing costs and fees you will want to add that in.  Generally, unless I am absolutely certain that my property has appreciated, I don't bother including appreciation in the calculation.  I use my purchase price as the actual value.

In the example above where the property is paid off you would only be getting a 2.5% return on equity.  Assuming rents increase as fast as you buy principle down then you continue to do well.  In my case I only do 10-15 years loans so i usually pay principle down faster than rents increase.  Thus, my ROE slowly gets worse and worse and once I drop below 10% ROE that is my signal to re leverage my equity, to keep it working hard for me.

This feels long winded and possibly not all that intelligable. if so, I apologize and just ignore it. Long story short, add principle payment into the amount you have invested when calculating ROI, because that is your money.

Wow! I will need to re-read this when I didn't just wake up. :-P It seems as though the way you calculate ROI is consistent with what I am trying to accomplish. Thank you for your insight!

I think this will also help me figure out what to do with my primary residence- rent or sell. :-)

[Brianna H.]

Originally posted by @Bill Gulley:

"Accurately" and "estimate" should not be used in the same sentence.

 Thanks for your insight, and yes I agree...accurate and estimate should NOT be in the same sentence and the title looks really silly to me now. :-P

You're right...I shouldn't waste too much time trying to figure out the ROI. I know it won't predict my future returns. I was just curious because so many people post about an ROI and I am hesitant to post anything similar because I don't feel like I have an accurate way to portray this, but now it sounds like no one really does. I'm thinking that ROI is really only effective in examining whether a house is worth buying as an investment.

[Jennifer Lee]

HI @Brianna H.

Interesting topic, I have re-learnt a lot,

I am a finance major in school. But never used my degree in the working world. But I think it helped me a lot in REI. Although I'm not sure which method I use. I just kinda made my "own" spreadsheet!

Since I buy mostly CASH, I feel that my ROI, CAP Rate and NOI almost reflect the same numbers. ( Correct me if I am wrong, I am not technical, I just know that my calc is accurate for my purposes)

WHAT I do , since I buy Value Add Stuff, and that usually means addressing CAPEX issues "now", is:

I do a CURRENT Return, and POTENTIAL Return and ACTUAL Return once it's working.

 Total Gross Annual Income (Projected with vacancy)

-Operating Expense

- Annual Taxes

-Insurance

-Mortgage (I know, I know, I shouldn't but I do)

This gives me a rough RETURN by Dividing by My TOTAL POTENTIAL CASH INJECTION.

------

Here is an example of my Return spreadsheet: it may be wrong but it works for me:

6 units commercial ( I use same calc for my single and multi) 

Semi Triple Net:

Current    Potential

Total Gross Rent/mo      $8,800     $14,3000 ( 50% vacancy when I bought it)

Total GAI    $105,600      $171,600

 Taxes         $23,000        $30,000  (I assume reassessment, I just bought this)

      Ins         $ 4,000          $ 4,000 

Financing    $48,000         $48,000  ( shouldn't be here, but it works for me)

_________________________________

NOI $30,600 $96,600

RETURN 3% 9% (Purchase price + Capex dollar= $1.155M)

This one is Triple Net, so I don't have Utilities/operating expense in here, my tenants pay, I do have house stuff, but that is calc in a different CAM spreadsheet sheet.  Also I did a other Spreadsheet with a TRUELLY triple net scenario with TAXES paid by tenants. and that yields 11% for me.

Then I did an ACTUAL, and see how I compare to my projections. And I m on par to my projections

With these 3 spreadsheet for all my properties, I get my big picture.

I also use this for my flip, but I would definitely have operating expense and I will use my purchase + Rehab Cost as my Base for return

sorry ran out of time to go into this further..

[Bill Gulley]

Originally posted by @Brianna H.:

Originally posted by @Bill Gulley:

"Accurately" and "estimate" should not be used in the same sentence.

 Thanks for your insight, and yes I agree...accurate and estimate should NOT be in the same sentence and the title looks really silly to me now. :-P

You're right...I shouldn't waste too much time trying to figure out the ROI. I know it won't predict my future returns. I was just curious because so many people post about an ROI and I am hesitant to post anything similar because I don't feel like I have an accurate way to portray this, but now it sounds like no one really does. I'm thinking that ROI is really only effective in examining whether a house is worth buying as an investment.

You're right, others that post ROI don't understand it. Realtors and seller use claims as a way to catch a buyer's attention, if any really understood the matter, they wouldn't say what they do.

Which also means, an estimated guess of what your ROI might be isn't a good basis for making a purchase decision. I have never used ROI or ROE in a purchase decision, never, estimating cash on cash, yes!

Restated, ROI is applicable to a company's performance, or that of a portfolio where different investments are considered on a collective basis, it's not a reliable or relevant analysis for one single property.

Never use a seller's numbers, yours will likely be different, if nothing else, by inflationary costs, taxes go up, insurance goes up, utilities will go up or the usage won't be identical, some seller's numbers put you in a ball park, usually in the parking lot, not at home plate. Numbers should come from your own due diligence. It's important to know how we arrive at the numbers, but with experience, you can look at a SFD and know if it's a good deal without ever punching a button on your calculator!

Best of lock :)    

[Blair Knowles]

Thanks for taking the time to ask @Brianna H. and @Dominic Jones! I have also learned a lot from this thread. 

[Jacob Sampson]

@Brianna H. 

I think the fact that you just woke up is less the issue than the fact that I feel the need to use 100 words where 5 will suffice.  My main point was just that the principle portion of your mortgage payment is no different than the money you used to purchase the property so each month the amount you have invested increases by a bit.  That should be taken into account in your calculations.

Also, As you have found, monthly calculations of either ROI or ROE are nearly useless as decision making tools. Those are better used when you have a year or more of data, where you can figure out what a long term average ROI/ROE is.