ROI or cashflow....or both?

Question

Hi BPers!   I'm just trying to figure out what is better to shoot for.  Cashflow or ROI.  I can't seem to find anything that gets better than 10% ROI.  This is cash on cash.  I do have to finance.  I hear a bunch of people saying they won't purchase unless they get 15%.  Should I be shooting for higher or is 10% ok?  Or should I just be happy if I feel the cashflow is worth it?

Andrew Johnson · Answer

@Dan Miles For me it's more around risk-adjusted returns.  If you're going to go into a market you don't know, warzone, far away, etc. then the potential return has to be higher.  In most cases (isn't generalizing fun?) the higher the ROI the less desirable the property/area/etc.  Everyone wants to buy in San Francisco, you compete with homeowners and investors, and ROI (taking appreciation out of it) is extremely low.  The same can be said for most areas of Los Angeles, San Diego, Denver, etc.  Now go to a dicey area of Ohio where almost all properties are owned by investors.  It's not as desirable, appreciation isn't much in play, you don't have to compete with homeowners, etc.  Prices are lower, cash-on-cash or ROI returns get better.  What you have to figure out is what your strategy is.  There isn't a right vs. wrong here.  Most of it is based on your philosophy, ideas on where the market is going, etc.

Some people love the returns of a Class D area, some people avoid it like the plague.  I'd hazard to guess there are people that will buy in places like San Francisco, be content with a "break even" cash-flow proposition, and believe they will make their money on mortgage pay down (building equity) and appreciation.  What they believe and I believe aren't going to be relevant to you.  You have to develop your own thesis (or adopt someone else's) so that you can map potential properties against it.  Otherwise you'll be wandering around in the dark.  My two cents anyway...

Andrew Johnson · Answer

@Dan Miles By the way, real fun starts when you start looking at things like marginal tax rates.  @Justin R. and I both live in San Diego.  If he makes $500K/year and I make $50K/year we're paying Uncle Sam very different ordinary income tax rates.  Justin probably only wants cash-flow if it's tax free; income balanced against mortgage interest deductions and deprecation.  Ol' Andrew on the other hand won't care as much because I get to *keep* a much greater percentage of that cash-flow.  So even though Justin and I could live down the street from each other (not likely with my crazy hypothetical income disparity, but you get the point) we might have extremely different preferences on the usefulness of cash-flow, appetite or debt, appetite for risk, etc.  Consequently, deals that we look at will be appealing (or not) based on that lens.

Just another layer of why it's important for you to develop your own thesis around your goals, where you think the market is heading, your preference for risk-adjusted returns, etc.

David Faulkner · Answer

... and while we are on the subject of risk, let us also talk about control, because the two go hand-in-hand. Control in the hands of a skilled REI operator is what allows most risks to be analyzed, hedged, mitigated, and often avoided all together. Control is one of the major things that makes REI such an attractive investment class, the others are leverage, market inefficiency, and tax benefits BTW. The farther away from home your investment properties are, the more control you will give up ... especially as a newbie. So, not only do you have to consider tax rates, and risk adjusted returns, but part of that risk assessment is your ability to control the asset and its operations. Who knew that such a seemingly simple question would have such a nuanced and intricate answer ... welcome to the wonderful world of REI :)

Justin R. · Answer

Yeah, most people aren't thinking about risk-adjusted returns, or have found ways to limit their risk that others investing in that market haven't.

Personally, I'd suggest what @Andrew Johnson said - think about what sort of investment style would bring you happiness, then find someone who's successful at it and copy their strategy.

For example, I'm happiest when I'm  creating things ... found my niche in urban development for rentals.  That may be the absolute worst strategy for someone who excels at scale.  Similarly, if I was investing in areas I can't see and touch, I'd be unfulfilled.

Dan Miles · Answer

I like that, Andrew.  I never really heard anyone explain it like that.  Makes sense!

ROI or cashflow....or both?

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