What is a reasonable ROI?

[Peter O.]

This is my first post here, and I am just starting out, trying to learn, and hoping to make my first purchase, so please be patient if I am asking very basic questions. I just analyzed a property using the Bigger Pockets rental property calculator. I get a CoC ROI of 6.09, and a 5-year annualized return of 15.44. Now, I know that historic stock-market performance is about 7%.

My first question is, which number should I be looking at? Should I be comparing the 7% I will likely get by investing in an index fund versus the 6.09% CoC ROI, or the 15.44% 5-year annualized?

My second question is, are these good numbers? What would you consider to be a minimum return before you buy? After all, any purchase would require a lot of work, both before and after purchase, so I would like to be making more than the stock market to make it worth it.

Thank you in advance for your help. 

[Andrew Eherts]

Hi Peter!

You raise some pretty nuanced questions. Comparing real estate returns to the stock market is pretty tough unless you adjust them to reflect risk adjusted returns. Historically, real estate is less volatile than the stock market, and you get more return per unit of risk you take (depending on what you invest in!). That's not a number that can be calculated easily though...

CoC is better related to coupon or dividend investments. Try getting a bond that pays 6%+ these days! I'd say it's a win, but what is a "good" return is relative to your goals. EPS is also very low as Price/Earnings keeps skyrocketing. 15% annualized is pretty nice--does that include a sale?

My current criteria is a 15% internal rate of return and a 6-9% CoC, which accounts for the time-value of money. It looks pretty similar to what you have underwritten in your post.

[Joe Villeneuve]

This isn't the stock market. Don't analyze it the same way, or compare your investment to it...or use percentages to analyze REI in the first place. 5% profits plus cash flow in your REI should be greater than 15% return in the stock market...from day one...and leave the SM in its dust exponentially.

As far as REI, again, don't measure your REI by "%"...you'd be missing most of what REI has to offer. When you look for your "returns" om REI you should measure them based on those returns accomplishing specific financial goals...YOUR specific financial goals. To that end, each has a specific financial purpose/use. Profit (lump sum returns) should be used to pay off personal (this does NOT include REI mortgages...that's not personal) debt. Cash flow (returns come regularly in pieces) should be used to pay off all your monthly bills. Neither number needed comes in the form of a percentage...they come in dollars...SPECIFIC dollars. So, you should be analyzing the "profits" gained in a RE deal in terms of how they payoff their specific use...not in a percentage.

[Peter O.]

Originally posted by @Andrew Eherts:

Hi Peter!

You raise some pretty nuanced questions. Comparing real estate returns to the stock market is pretty tough unless you adjust them to reflect risk adjusted returns. Historically, real estate is less volatile than the stock market, and you get more return per unit of risk you take (depending on what you invest in!). That's not a number that can be calculated easily though...

CoC is better related to coupon or dividend investments. Try getting a bond that pays 6%+ these days! I'd say it's a win, but what is a "good" return is relative to your goals. EPS is also very low as Price/Earnings keeps skyrocketing. 15% annualized is pretty nice--does that include a sale?

My current criteria is a 15% internal rate of return and a 6-9% CoC, which accounts for the time-value of money. It looks pretty similar to what you have underwritten in your post.

Andrew, thank you for your help! The example in question involves purchasing a property, with a 20% down payment. I assumed a 4% interest rate on a 30 year mortgage. The property in question already has tenants, so I had rent amount already available.

[Peter O.]

Originally posted by @Joe Villeneuve:

This isn't the stock market. Don't analyze it the same way, or compare your investment to it...or use percentages to analyze REI in the first place. 5% profits plus cash flow in your REI should be greater than 15% return in the stock market...from day one...and leave the SM in its dust exponentially.

As far as REI, again, don't measure your REI by "%"...you'd be missing most of what REI has to offer. When you look for your "returns" om REI you should measure them based on those returns accomplishing specific financial goals...YOUR specific financial goals. To that end, each has a specific financial purpose/use. Profit (lump sum returns) should be used to pay off personal (this does NOT include REI mortgages...that's not personal) debt. Cash flow (returns come regularly in pieces) should be used to pay off all your monthly bills. Neither number needed comes in the form of a percentage...they come in dollars...SPECIFIC dollars. So, you should be analyzing the "profits" gained in a RE deal in terms of how they payoff their specific use...not in a percentage.

 Joe, thank you for your help! Re paying off my monthly bills, are you talking about paying off the bills on the investment property, or my personal bills? If it's on the investment property, I can pay off all my bills and have a small profit each month (not counting the increase in my equity from paying off the morgage). I am of course making some assumptions, but I know some firm numbers, including the rental income (it has existing tenants), and the taxes, and I erred on the side of caution with a $1,200/year insurance and a 10% repair and maintenance and 10% capital expenses. I don't know the vacancy rate for that town, so I put down the state's vacancy rate.

[Joe Villeneuve]

Personal mot investment bills.  The investment should pay for itself, and the cash flow after the investment expenses have been paid will pay for your personal expenses.