Is Profit Per Hour Invested The Best Return Metric For RE Investing?

[Bryan Hancock]

I am reading a book by a well-known author right now and he has some disparaging remarks for yield measurements for real estate investing. I tend to agree with him given that most real estate activities carry a huge time element that is completely ignored from most yield analysis. I see two ways to fix this:

1. Value your investments using profit per hour invested
2. Account for your time in your investment models including time spent on overhead and such...a tall order!

Item 2 also begs the question about what dollar amount to put on your time. With fluid projects you could get this using item 1, but that would just mean that item 1 is a better idea anyway!

Is profit per hour a better metric for real estate investments than IRR, MIRR, ROI, COC, XIRR, NPV, or anything that the finance textbooks use?

[Paul B.]

I think you have to look at just as you would owning a small business. The fact is that too many small business owners are really doing nothing more than creating jobs for themselves; they are not creating anything of true economic value.

By that I mean let's say someone invests $400,000 in a donut shop and their target return is 10% on their capital. At the end of the year, the shop has a $40,000 profit, which the owner takes to compensate himself for his time. He also figures it's about what he'd earn as a donut shop manager, so fair enough.

If that's the case, he's really earned nothing on his $400,000. He could have just as easily gotten a job as a donut shop manager without risking $400,000. So in fact, he has not earned an economic profit. (You could now get into things like the cost of capital, etc., but no sense making things more complicated.)

Therefore, I think when you're looking at your real estate investments, you have to assign some value to your time, and deduct that value from your profits to see what your "real" profit is from investing your capital.

If (1) you have $500,000 in equity capital tied up in real estate and (2) you're netting $200,000 a year from your efforts and (3) you spend 1,000 hours a year on the business and (4) you have other earning opportunities that would pay you $100/hour (and you could bill 1,000 hours a year at that rate), the value of your time is $100,000, so your true real earnings on your real estate capital are $100,000, or 20% of your $500,000.