What are the Rules for ROI?

Question

In my experience selling investment properties I've seen many different strategies investors use to determine how they look at an investment. Some go off the margin, they want 20-30% return for each property, others go on bulk and they are just looking at the net profit on each flip.

What do you look at and why?

Scott Trench · Answer

ROI and returns are only relevant if they do the following:

1) Provide greater returns per the work involved than the next best thing you can do with your money

2) Are meaningful relative to your financial position

Think about this logically - if you have the "opportunity" to purchase a case of 50 waters for $20, and sell them for $2 apiece outside of the ballpark, you earn an "ROI" of 500% and 5x your investment.

That's a smart move for someone with only $20, but a total waste of time for someone considering real estate, likely with $10, $20, or even $100K in savings.

The same, however, applies in real estate investing with the different investments available to us. Currently, I'm investing in small duplexes and quads here in Denver. Already, a $50K property in the midwest is a total waste of my time, as I'd have to learn the market, understand a new city and type of investing, and my upside is at best 10-20% returns annually. That kind of ROI is not worth my time, even though it might be slightly higher per property than the investments I have here in Denver. That said, it would take more work, and be a big bother to gain the knowledge necessary to compete in those markets.

Since I can get close to that level of return (hopefully) with much more valuable properties out here in Denver, I don't bother with out of state small fish.

I expect in a decade or so for even these duplexes and quads that I'm buying today to be relatively insignificant to my portfolio, assuming I continue to scale. At that time, I'll have to look to larger and larger projects to meet those two criteria I outlined above.

ROI is important, but only in the context of meaningful investments.

That said, you can scale with smaller properties and smaller investments, but only if you systematize the processes for building a business with them.

Micki M. · Answer

Well said @Scott Trench I've been dabbling in different facets of real estate and learning your first point.  Once you try something and see the effort required for the net return it definitely gives you perspective. For example a 12% return on a renovation project is respectable but if you could earn that by privately lending the cash instead you'd make the same money for less effort and less risk.

Gino Barbaro · Answer

@Jason Utley

Hi Jason

It depends on an investor's strategy.  I like to look at Cash on Cash, around 10% actual numbers.  I also look at cap rates, around 8 and DSCR of at least 1.2.  I am a buy and hold investor who now concentrates on multifamily properties.

Most investors don't take into consideration the tax benefits of real estate.  With the larger properties, you can employ cost segregation to take advantage.  Even regular depreciation is a huge bonus.  Some investors also forget to calculate the principal pay down of the mortgage.

I also think many investors confuse investing with speculating.  Wholesaling and fix and flipping are not investing.  To me, they are a form of speculating, buying something at one price and hopefully selling at a higher price.  I think they are great strategies, but not investing.

Gino

Brad Saari · Answer

Just so I'm clear when you say ROI on a buy and hold does that include cash flow, appreciation and equity from loan pay down? I'm factoring in 3% appreciation in the Denver market which is obviously low now but trying to keep some historical perspective...market can't stay this hot forever.

Nico Viola · Answer

Margins are the name of the game. Volume is not the way to go at all in my opinion. I'd rather wait to find the right deal that is going to make for a nice payday then pick up a bunch of properties that will each make a smaller return.

Each deal is different. My strategy on a buy and hold is far different then on a flip. With a buy and hold I am looking at long term ROI. How much will I make annually in rent and how much will I net off the sale of the property down the road. These are investments I make in areas I expect values to raise significantly down the road and I am willing to take a lower margin in the short term for the large payout in the end. On these deals I am still looking to clear 20-30% annually.

On a flip, I want to be in and out ASAP and make a minimum of 30% ROI otherwise its not worth my time. Everyone has there own strategy but the numbers don't lie.

Jeff B. · Answer

Unlike fast food franchising, I don't see volume sales as a reasonable means to get ROI.

Increased volume has linear increased risk with marginal improvement in the net.

There's too much work to operate a rental or flip & rehab to take $1.95 margin for each effort.

It is true that the sum of the parts is greater than the whole, but that's in paper, not cash.

my $0.02

What are the Rules for ROI?

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