Calculating ROI - P&I and depreciation expense

[Tom Boutureira]

Hi All. I'm looking at rental income properties and experimenting with the Four Square method to calculate ROI. The purchase will require financing.

The Bigger Pockets method includes both principal and interest for the mortgage expense line in box 2 (Expenses). That results in a lower ROI because it does not account for principal payments as home equity (or planned savings...granted it's not liquid cash) that can be added to annual income to calculate a revised annual return over a target time period (5/10/15 years).

I'm wondering why the Four Square method doesn't just use the interest payment as the mortgage expense line when calculating ROI. In this case an investor would need to have a target investment timeline (5/10/15 years) and could use the amortization schedule to calculate average principal and average interest amounts for that timeline. My guess is because it's looking at things from a purely cash (cash flow) basis to calculate affordability (can I afford this) and to calculate ROI (annual income to initial investment)with the logic being that regardless of whether it's principal or interest, it's still a monthly fixed payment.

The other piece that isn't accounted for is that on a normal investment (say an index fund or individual stock) you would pay tax on the gains in a given year. For real estate that income is adjusted down by the depreciation expense. So that isn't calculated into the ROI either, but could provide for additional return.

Anyone have some insights and suggestions on this topic?