{"id":162521,"date":"2023-11-20T14:33:18","date_gmt":"2023-11-20T21:33:18","guid":{"rendered":"https:\/\/www.biggerpockets.com\/blog\/?p=162521"},"modified":"2023-11-20T14:33:20","modified_gmt":"2023-11-20T21:33:20","slug":"risk-adjusted-returns-are-more-important-than-roi","status":"publish","type":"post","link":"https:\/\/www.biggerpockets.com\/blog\/risk-adjusted-returns-are-more-important-than-roi","title":{"rendered":"I&#8217;ve Had Enough\u2014It&#8217;s Not About ROI, It&#8217;s About This"},"content":{"rendered":"\n<p><span data-preserver-spaces=\"true\">I\u2019m fed up. I have been for years, actually. Everywhere I turn, I read and hear from investors obsessed with return on investment (<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.biggerpockets.com\/blog\/what-is-roi-in-real-estate\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">ROI<\/span><\/a><span data-preserver-spaces=\"true\">). Or worse, they talk about the internal rate of return (<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.biggerpockets.com\/blog\/internal-rate-return-irr\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">IRR<\/span><\/a><span data-preserver-spaces=\"true\">), which less than one in a hundred investors really understand.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">This is what drives some into speculative strategies cleverly cloaked as investments. We\u2019ve never seen these successfully build sustainable wealth. More often than not, these speculative strategies\u00a0<\/span><em><span data-preserver-spaces=\"true\">lose\u00a0<\/span><\/em><span data-preserver-spaces=\"true\">money.<\/span><\/p>\n\n\n\n\n\n\n  <div class=\"lg:block\" x-data=\"{ ad_block_block_655bd038f4dd5: popAds(1) }\">\n      <template x-for=\"ad in ad_block_block_655bd038f4dd5\">\n        <a\n          :href=\"ad.linkURL\"\n          class=\"no-underline text-black\"\n          x-on:click=\"adClicked('https:\/\/www.biggerpockets.com\/blog\/risk-adjusted-returns-are-more-important-than-roi', ad.sponsor, ad.title, ad.id, 'blockAdClicked', 'blockAd', '')\"\n          target=\"_blank\">\n          <div\n            class=\"py-4 border-b flex flex-col flex-nowrap text-sm border-t px-0 rounded-none\"\n            x-init=\"\n              analytics.track('blockAdLoaded', {\n                referrer: 'https:\/\/www.biggerpockets.com\/blog\/risk-adjusted-returns-are-more-important-than-roi',\n                sponsor: ad.sponsor,\n                ad_title: ad.title,\n                ad_page_location: ''\n              })\n            \"\n            x-intersect:enter.once=\"adViewed('https:\/\/www.biggerpockets.com\/blog\/risk-adjusted-returns-are-more-important-than-roi', ad.sponsor, ad.title, ad.id, 'blockAdViewed', 'blockAd', '')\">\n            <div><span class=\"text-xs text-slate-light block bg-slate-50 p-1 inline-block rounded-md\">Sponsored<\/span><\/div>\n            <div class=\"flex items-center text-sm space-x-4\">\n                <img :src=\"ad.imageURL\" :alt=\"ad.imageAlt\" class=\"h-10 w-10 object-cover rounded-full\">\n\n                <div clas=\"text-sm\">\n                    <span class=\"font-bold block\" x-text=\"ad.sponsor\"><\/span>\n                    <span class=\"text-slate\/80\" x-text=\"ad.description\"><\/span>\n                <\/div>\n            <\/div>\n\n            <div>\n                <span class=\"font-bold\" x-text=\"ad.title\"><\/span>\n                <p class=\"mt-2 text-slate\/80\" x-text=\"ad.body\"><\/p>\n                <span class=\"mt-2 text-themeBlue block mt-2 underline\" x-text=\"ad.linkTitle\"><\/span>\n            <\/div>\n          <\/div>\n        <\/a>\n      <\/template>\n  <\/div>\n\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Speculation vs. Investing<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">Since I\u2019ve been writing for BiggerPockets, my goal has been to educate investors on the difference between investing and speculating. With that in mind, here\u2019s a look at the difference:&nbsp;<\/span><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><strong><span data-preserver-spaces=\"true\">Investing:&nbsp;<\/span><\/strong><span data-preserver-spaces=\"true\">When your principal is generally protected, and you\u2019ve got a chance to make a profit.&nbsp;<\/span><\/li>\n\n\n\n<li><strong><span data-preserver-spaces=\"true\">Speculating<\/span><\/strong><span data-preserver-spaces=\"true\">: When your principal is not at all protected, and you\u2019ve got a chance to make a profit.&nbsp;<\/span><\/li>\n<\/ul>\n\n\n\n<p><span data-preserver-spaces=\"true\">In short, high-stakes speculating is exciting, while lower-risk investing is relatively boring.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Books are written about speculation. Movies are made, too. Why? Because those \u201cone-in-a-million\u201d stories are exhilarating. Despite the high risk and poor odds, most of us dream about being the exception: \u201cMaybe it will work for me. Maybe I\u2019m the one!\u201d<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Stop believing those Hollywood lies. The&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.biggerpockets.com\/blog\/money-451\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">path to true wealth<\/span><\/a><span data-preserver-spaces=\"true\">&nbsp;is boring and far less dramatic than fairy tales.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Speaking of true wealth, have you ever considered what that is? It\u2019s not defined by a Rolex, an exotic sports car, or a mansion on the hill.<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">True Wealth = Owning Assets that Produce Reliable Cash Flow<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">The truth is, you won\u2019t obtain true wealth by obsessing over IRRs and clambering for the highest real estate returns any more than you would profit from checking individual stock prices hourly.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">If you just want a high return, buy a lottery ticket. Lottery tickets pay the highest returns on the planet. But that\u2019s not a viable investment strategy\u2014ask any broke gambling addict.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">If you want reliable investments, focus on risk-adjusted returns.&nbsp;<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Risk-Adjusted Returns<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">Here is the definition, according to&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.investopedia.com\/terms\/r\/riskadjustedreturn.asp\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">Investopedia<\/span><\/a><span data-preserver-spaces=\"true\">:<\/span><\/p>\n\n\n\n<p><em><span data-preserver-spaces=\"true\">\u201cA risk-adjusted return is a calculation of the profit or potential profit from an investment that considers the degree of risk that must be accepted to achieve it. The risk is measured in comparison to that of a virtually risk-free investment\u2014usually U.S. Treasuries.\u201d<\/span><\/em><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">There are various methodologies used to calculate risk-adjusted returns for stocks, real estate, and other assets. Unfortunately, I don\u2019t believe any of them adequately measure risk for most investors, especially for real estate investors.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">I used to think the Sharpe Ratio did the trick, but Warren Buffett and Stephen Marks convinced me their measurement (standard deviation) was a poor marker for risk.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Rather than theorize about math and statistics, I encourage real estate investors to carefully consider the likelihood that this investment will succeed or fail. Utilize this risk factor in your evaluation and comparison of investment opportunities.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Here are a few of the many,&nbsp;<\/span><em><span data-preserver-spaces=\"true\">many<\/span><\/em><span data-preserver-spaces=\"true\">&nbsp;factors you may want to consider in evaluating risk:&nbsp;<\/span><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><span data-preserver-spaces=\"true\">The experience and team of the operator.<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">The operator\u2019s financial skin in the game for this investment.<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">The debt (leverage, term, interest rate risk, and more).<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">The operator\u2019s operating and\/or value-add strategy and execution potential.<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">The location (there are a few dozen factors here, including population migration, crime, and more).<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">The underwriting model (revenue and expense projections, tax and insurance hikes, and dozens of other factors).<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Macroeconomic and microeconomic factors that could impact the asset\u2019s performance.<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Diversification of risk (this can mean many different things, depending on the deal).<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">So much more.<\/span><\/li>\n<\/ul>\n\n\n\n<p><span data-preserver-spaces=\"true\">Note that uncovering and evaluating these factors is a matter of thorough&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.biggerpockets.com\/blog\/rookie-190\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">due diligence<\/span><\/a><span data-preserver-spaces=\"true\">. Do you have the knowledge, tools, experience, and time to get to the bottom of these issues and a hundred more?&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">It\u2019s a matter of having the courage to not get emotionally attached to the investment during the evaluation process. Emotional engagement causes investors to develop unhealthy biases that skew their thinking and decisions. Confirmation bias will tempt the investor to seek out and heavily weigh the evidence that supports their desire and to ignore contrary evidence.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">You will want to compare the resulting projected risk-adjusted return to other potential investments available. Many investors compare their opportunities to the \u201crisk-free rate\u201d generated by U.S. Treasuries.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">At the time of this writing, that rate is more appealing than it\u2019s been for many years. Low rate or high, the return offered by Treasuries hasn\u2019t stopped Warren Buffett from parking over $100 billion in cash in these instruments for over five years and counting.&nbsp;<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">WWBD? (What Would Buffett Do?) An Application of Risk-Adjusted Return<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">In the most ominous weeks of the 2008 financial crisis, Warren Buffett invested $5 billion in Goldman Sachs as its share price was hurtling toward zero.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">But he didn\u2019t invest in common equity or debt. He invested in&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.biggerpockets.com\/blog\/preferred-equity-can-improve-your-returns-in-this-environment\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">preferred equity<\/span><\/a><span data-preserver-spaces=\"true\">\u2014and created a lot of wealth for both himself and his investors.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">In the spirit of Buffett, we\u2019ve been discussing preferred equity investments for commercial real estate assets to create theoretically higher risk-adjusted returns for investors.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">It may not be 2008, but we think the current economic storm warrants similar out-of-the-box thinking. And I think preferred equity provides investors with a theoretically safer position in the&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.biggerpockets.com\/blog\/multifamily-capital-stack\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">capital stack<\/span><\/a><span data-preserver-spaces=\"true\">, with contractual cash flow and upside, in times like this.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">A more protected position in the capital stack, contractual returns from day one, management controls, forced sale rights, personal guarantees, cash management, and reserves are some of the factors that potentially reduce risk for many preferred equity investments. This is how our team is applying risk adjustments to our portfolio in the current environment.\u00a0<\/span><\/p>\n\n\n\n    \n  <div id=\"visibility-group-block_f9a19f9638bbbd5270f1f0417c1598a9\" class=\"visibility-group  hidden\">\n        \n\n<div id=\"hero-block_853a6ef4653dd47d5ec62c75cd552018\" class=\"first:mt-0 hero-block py-4  alignwide   has-background has-theme-gold-light-background-color has-text-color has-theme-gold-color\">\n    <div\n        class=\" flex flex-wrap lg:flex-nowrap max-w-screen-xl mx-auto px-4 relative lg:items-center \">\n\n        <div class=\"relative z-30 w-full \">\n            <main class=\"py-4\">\n                \n\n<p class=\"has-theme-gold-color has-text-color has-large-font-size\" style=\"font-style:normal;font-weight:800\">Get the Best Loan Today<\/p>\n\n\n\n<p class=\"my-3 md:my-5 lg:my-8 has-slate-900-color has-text-color\" style=\"font-size:16px\">Find trusted, <em><strong>investor-friendly<\/strong><\/em> lenders who specialize in your strategy. <\/p>\n\n\n\n<p><\/p>\n\n\n\n<div id=button-custom-event-block_bd26775c6b223916128b060fedb6bf0c class='button-custom-event'>\n      <a href=\"https:\/\/www.biggerpockets.com\/business\/finder\/lenders\" x-on:click=\"window.analytics.track(&#039;Blog Block | B2C Marketplace Lender Finder&#039;, {\n      referrer: &#039;https:\/\/www.biggerpockets.com\/blog\/risk-adjusted-returns-are-more-important-than-roi&#039;,\n    });\" class=\" btn-shape inline-block no-underline has-background has-theme-gold-background-color has-text-color has-white-color\" target=\"_blank\">Find a Lender<\/a>\n  <\/div>\n\n            <\/main>\n        <\/div>\n\n                <div class=\" first:mt-0 relative h-full lg:flex lg:items-center\">\n            <img decoding=\"async\" class=\"object-cover w-full relative z-20 my-0  rounded-md hidden lg:block\" src=\"https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2022\/08\/Marketplace-Blog-Blocks-Lender-v3.png\" alt=\"investor friendly lender, investor friendly real estate loans\" title=\"\">\n        <\/div>\n            <\/div>\n<\/div>\n\n  <\/div>\n  \n\n\n<div class=\"wp-block-group\"><div class=\"wp-block-group__inner-container is-layout-constrained wp-block-group-is-layout-constrained\">\n    \n  <div id=\"visibility-group-block_64dd31c79f00f\" class=\"visibility-group  \">\n        \n\n<div style=\"height:10px\" aria-hidden=\"true\" class=\"wp-block-spacer\"><\/div>\n\n\n\n<div id=\"hero-block_64dd2875dba9d\" class=\"first:mt-0 hero-block py-4    has-background has-slate-100-background-color has-text-color has-theme-slate-color\">\n    <div\n        class=\" flex flex-wrap lg:flex-nowrap max-w-screen-xl mx-auto px-4 relative lg:items-center \">\n\n        <div class=\"relative z-30 w-full \">\n            <main class=\"py-4\">\n                \n\n<h3 class=\"wp-block-heading my-0 tracking-tight font-extrabold has-theme-slate-dark-color has-text-color has-large-font-size\">Join the community<\/h3>\n\n\n\n<p class=\"my-3 md:my-5 lg:my-8 has-theme-slate-color has-text-color\" style=\"font-size:16px;font-style:normal;font-weight:400\">Ready to succeed in real estate investing? Create a free BiggerPockets account to learn about investment strategies; ask questions and get answers from our community of +2 million members; connect with investor-friendly agents; and so much more. <\/p>\n\n\n\n<div id=button-custom-event-block_64dd2888dba9e class='button-custom-event'>\n      <a href=\"https:\/\/www.biggerpockets.com\/signup\" x-on:click=\"window.analytics.track(&#039;Blog Block | Acquisition | Free Membership Signup&#039;, {\n      referrer: &#039;https:\/\/www.biggerpockets.com\/blog\/risk-adjusted-returns-are-more-important-than-roi&#039;,\n    });\" class=\" btn-shape inline-block no-underline has-background has-theme-blue-background-color has-text-color has-white-color\" target=\"_blank\">Sign Up<\/a>\n  <\/div>\n\n            <\/main>\n        <\/div>\n\n            <\/div>\n<\/div>\n\n\n<div style=\"height:10px\" aria-hidden=\"true\" class=\"wp-block-spacer\"><\/div>\n\n\n  <\/div>\n  <\/div><\/div>\n\n\n\n<p><em>*All investments are subject to risks, including the loss of all principal invested. Past performance is no guarantee of future returns, and the investment objectives of WREIF may not be achieved. Investors should consider the investment objectives, risks, charges, and expenses carefully before investing. For a prospectus or a summary prospectus with this and other information about the Fund, please call (800) 844-2188 or visit the Fund\u2019s website, wellingscapital.com. Read the prospectus carefully before investing.&nbsp;<\/em><\/p>\n","protected":false},"excerpt":{"rendered":"<p>Stop being concerned with ROI and IRR. Stop putting yourself in speculative positions. The path to wealth is boring, and this is what you should be paying attention to.<\/p>\n","protected":false},"author":214608,"featured_media":162524,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[4433],"tags":[],"class_list":["post-162521","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-opinion"],"acf":[],"comment_count":0,"_links":{"self":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/162521","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/users\/214608"}],"replies":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/comments?post=162521"}],"version-history":[{"count":0,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/162521\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media\/162524"}],"wp:attachment":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media?parent=162521"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/categories?post=162521"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/tags?post=162521"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}