The Truth About ROI (aka Your Rate of Return)

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“82% ROI, come and get it!!” (yells through megaphone, waves flag…) Can you picture it? I can.

Who wouldn’t want an 82% return on investment? You’d have to be out of your mind to say no to that. Well, then why do people say no? Because what a seller claims the rate of return (ROI) on a property to be may not be completely accurate.

Two Reasons a Seller’s Claim on ROI Might be Bunk

  1. The calculations or assumptions the seller uses to come up with ROI may be misleading or inaccurate.
  2. The tenant quality may be so bad that there is no feasible way to realistically get the advertised return due to evictions, vacancies, and repairs.

How ROIs are (Should Be) Calculated

No calculated ROI is for sure, but there are ways to make it as accurate as possible. Conversely, there are ways make an ROI look really stellar. While not technically lying, sellers often reply on assumptions that can’t possibly be that accurate. Maybe in fantasy land, or years ago before the market crash, but making some of these assumptions today has to be the stupidest thing an investor can do.

 “Dude, this property has an 82% ROI!”

“Really, how do you get to that number?”

“Not sure, but doesn’t an 82% ROI sound awesome?  You should buy it and then you can tell people you are making an 82% ROI.”

What are some of those assumptions?

  • Appreciation Expectations. I shouldn’t even have to elaborate on this one. Appreciation used to happen pretty nicely, but as we all learned just a few years ago, it’s far from guaranteed! So don’t even include it in your “ROI”. Please. (more like puh-lease)
  • Depreciation and Tax Benefits. Yes, these come with real estate investments, mostly rental properties. I agree that these benefits are definitely part of your overall ROI, but trying to calculate them into an actual number is just a ridiculous stretch. Consider those benefits (and they are nice ones!) as bonuses. Never rely on them to justify buying a particular property. Plus you never know from year to year what changes to the tax system the government will make so don’t rely on today’s tax rules for tomorrow’s return. {looking you, Obama…}
  • Mortgage Pay-Down Assumptions. These are great if/when they happen, but you still don’t know what the exact situation will be later, so relying on these is really stretching it too.

I’m sure there are plenty of other assumptions floating around out there. The big one that really sticks me in the side is when I see appreciation charts as a justification that a property is a good investment.

The First (and Only) Rule of Investing

Don’t lose money.

Simple, huh? I think so. But apparently it’s not because people lose money all the time. Never rely on the hypotheticals, the assumptions, the what-if’s, the anything. Cash flow matters. Cash flow you know. Appreciation you do not. Tax benefits you do not. Fancy inheritance you do not. Work for cash flow. If you can set yourself up to buy a property that for sure cash flows but then also has a nice appreciation potential, do it. That’s what I shoot for. I don’t by $20,000 properties because they will doubtfully go very far up. $100,000 properties, on the other hand, very likely to go up. I also don’t buy $20,000 properties because of the tenant quality. Bad tenant quality makes you lose cash flow, and the number one rule is not to lose that.

Final Thoughts

Always question a seller’s ROI calculation.

Use only known and realistic assumptions in your calculations.

Shoot for cash flow only and consider everything else a bonus.

Make sure you factor in vacancy and repairs, based on tenant quality and property condition, into your cash flow calculations.

About Author

Ali Boone

Ali Boone is a lifestyle entrepreneur, business consultant, and real estate investor. Ali left her corporate job as an Aerospace Engineer to follow her passion for being her own boss and creating true lifestyle design. She did this through real estate investing, using primarily creative financing to purchase five properties in her first 18 months of investing. Ali’s real estate portfolio started with pre-construction investments in Nicaragua and then moved towards turnkey rental properties in various markets throughout the U.S. With this success, she went on to create her company Hipster Investments, which focuses on turnkey rental properties and offers hands-on support for new investors and those going through the investing process. She’s written nearly 200 articles for BiggerPockets and has been featured in Fox Business, The Motley Fool, and Personal Real Estate Investor Magazine. She still owns her first turnkey rental properties and is a co-owner and the landlord of property local to her in Venice Beach.


    • James, you are right, but the premise is what is measurable. True ROI is not when it involves all of those other things. So maybe the thing to say then only the cash-on-cash matters, not ROI…as defined by your comment.

  1. Ali, I love it! You really are a sister from another mother 🙂

    People like to calculate the Internal Rate of Return (IRR) which does include all of that other stuff, but it has always been totally foreign to me why they bother. It’s purely academic. We can’t control the market, nor can we control the fiscal or monetary policies. Does the thing put dough in my pocket each month, or does it not – that’s what I want to know. It’s simple stupid – don’t lose money! That’s a function of cash flow, and backs into cash on cash and cap rate. The rest of it is nice to talk about at a cocktail party…

    Good article Ali

    • Haha, love the comment Ben. I love being someone’s sista from anotha mutha! I also enjoy cocktail parties 🙂

      Yes, I’m with you on why bother with the IRR or whatever ‘guesses’ people want to make. I want cash in my pocket, and bonuses are bonuses!

  2. I like “Don’t Lose Money” that is exactly what Warren Buffet said is the reason for his success.

    Along with ROI, I always factor in the ROR or “Return On Risk”, if things go South or the SHF I can know up front my highest possible loss. I use the ROR factor in the when trading in options, but also on my REI.

    • Ooh Dennis, good one. I didn’t even think about that perspective, but I’ve definitely done that in the past with some investments. I’ve thought “ok, worst case scenario this thing tanks, what do I lose?” And I think if more people did that they’d be shocked at how much less is at risk to lose than they may realize. Not all the time, but definitely in a lot of cases.

      Great comment!

  3. Chris Clothier

    Ali –

    You and I both know the biggest reason for some of the more crazy numbers is that many investors are prone to chase yield. They (we) are attracted to glitzy, glamorous numbers that blink at us like neon signs. I fell victim to it in the past too. But, you brought up something that really is the true difference maker – quality control. The better the renovation and the better the tenant selection and property management, the better your property is going to perform. I am not 100% sure how that correlates in terms of a number, but as an investor the numbers don’t matter if the renovation is poor and the management sucks…Your Property Will Lose Money!

    I love your writing and your attitude – Keep It Up! You are a great voice for other investors to listen to –


  4. She does it again 😉 Spot-on, Ali. Make reasonable assumptions, work out the worst case scenarios, and then shave another good 25% off your assumptions and make sure it all still works.

    Everything else (may happen, may not) is either icing on the cake, or a misfortunate occurrence that you should have (and definitely could have) planned for, or at least prepared for, had you made those reasonable assumptions above. You nailed it right on the head.

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