ROI for Rental Property vs. Other Investments

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ROI for Rental Property vs. Other Investments

Daniel Blake
Member since 2018 · 4 posts · 1 vote

Hey BiggerPockets community–

I need help being persuaded to invest in real estate. I've managed my personal assets for quite some time, investing in stocks and bonds mostly, with the occasional foray into other asset classes like gold.

As an investor, any investment I make needs to compete with my other options, i.e. my return on investment must be better than what I'd get with other investments.

When I calculate ROI on a buy-and-hold rental property, I'm not convinced it's an asset class worth investing in, especially considering all the time and stress involved, not to mention the liability risk of being a landlord. Because of this, I would require a much higher expected ROI on a rental property than I could get otherwise. ROI under 15% per year on average, I am not interested in. I'll just invest in more passive asset classes.

When I run the numbers on a potential rental property, assuming I can buy at a slight discount (say 5%), with a standard mortgage, a rent level that generates positive cash flow, and an annual projected appreciation of 4% a year, the projected ROI I'm seeing is modest, like around 10-15%, which does not justify all the headache and risk required investing in real estate. And this 10-15% average annual return is only seen after holding and successfully renting the property for at least 5 years.

And to be clear, the ROI I am using is calculated at sale of the property – total profit divided by total investment, annualized. This to me seems the most pure metric to measure the performance of real estate. And I tried to be as comprehensive in my modeling as possible, including purchase and sale closing costs, the value of tax deductions, management costs, etc.

I know this community is dedicated to investing in real estate specifically, but it's still an investment, and every investment is measured by the profit it can produce and must compete with other options.

What am I not understanding or missing here?

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Ali Boone
Real Estate Coach · Venice Beach, CA · Member since 2012 · 6k+ posts · 3k+ votes
6y

When you calculate the numbers and get that 10-15%, is that with financing or with an all-cash purchase? Let me know on that because that will make a huge difference, but then in the meantime, one thing to know is that there are multiple profit centers on a rental property. You mentioned the first two: cash flow and appreciation, but there are some more, too. (#4 plays into whether you're financing or not):

https://www.biggerpockets.com/...

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  • Ali Boone
    Real Estate Coach · Venice Beach, CA · Member since 2012 · 6k+ posts · 3k+ votes
    6y

    When you calculate the numbers and get that 10-15%, is that with financing or with an all-cash purchase? Let me know on that because that will make a huge difference, but then in the meantime, one thing to know is that there are multiple profit centers on a rental property. You mentioned the first two: cash flow and appreciation, but there are some more, too. (#4 plays into whether you're financing or not):

    https://www.biggerpockets.com/...

    2Reply
  • Mike Dymski
    Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
    6y

    Most of us would not invest actively in real estate for 10-15% either. You can achieve those returns investing passively in real estate (syndications, NNN). Many of us have 20+% target IRR for active investments...active investing is too much work to not achieve outpaced returns.

    1Reply
  • Daniel Blake
    OP
    Member since 2018 · 4 posts · 1 vote
    6y

    @Ali Boone My projections assume financing at the current mortgage rates, with a 25% down payment (the number most lenders require to get a sizable rate discount).

    Thanks for sharing that. I guess by "appreciation" I meant equity earnings, including both appreciation and mortgage payoff. I also factored in tax deductions from mortgage interest and property taxes, but these savings have a margin effect on ROI.

    I guess the big returns, 20%+, are just very, very hard to find. Anything less than that, and as @Mike Dymski said it's better just to pick some other passive investment, in real estate or otherwise.

    1Reply
  • Daniel Blake
    OP
    Member since 2018 · 4 posts · 1 vote
    6y

    @Mike Dymski This 20+% return you target... how is this return measured? Is it the same as my measurement of return, which is total profit if you sold the property, divided by original out-of-pocket investment (taking into account all closing costs, cash flow, price appreciation)? I get confused by all the different measurements of return and their respective terminology.

    0Reply
  • Mike Dymski
    Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
    6y
    Originally posted by @Daniel Blake:

    @Mike Dymski This 20+% return you target... how is this return measured? Is it the same as my measurement of return, which is total profit if you sold the property, divided by original out-of-pocket investment (taking into account all closing costs, cash flow, price appreciation)? I get confused by all the different measurements of return and their respective terminology.

    Your average annual return calculation is a common metric and a good clear way to look at return. Many of us use IRR (internal rate of return), which accounts for the timing of cash flows that is not addressed in the average annual return calculation. Equity multiple is another common metric, which is similar to your average annual return...how much is our original investment multiplied by the time we exit (i.e 2x after 5 years).

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  • Ali Boone
    Real Estate Coach · Venice Beach, CA · Member since 2012 · 6k+ posts · 3k+ votes
    6y
    Originally posted by @Daniel Blake:

    @Ali Boone My projections assume financing at the current mortgage rates, with a 25% down payment (the number most lenders require to get a sizable rate discount).

    Thanks for sharing that. I guess by "appreciation" I meant equity earnings, including both appreciation and mortgage payoff. I also factored in tax deductions from mortgage interest and property taxes, but these savings have a margin effect on ROI.

    I guess the big returns, 20%+, are just very, very hard to find. Anything less than that, and as @Mike Dymski said it's better just to pick some other passive investment, in real estate or otherwise.

    Where were you looking for or finding properties? That seems like a low % if you're taking all of that into account. And just remember- there are pros and cons to every strategy. Including the more passive ones.

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  • Kenneth GarrettPro Member
    Investor · Florida Panhandle/Illinois · Member since 2016 · 4k+ posts · 3k+ votes
    6y

    @Daniel Blake

    In your calculation it looks like your using CoC return, but that is not the only metric. Mortgage pay down, property tax and interest deduction, depreciation, and as you mentioned appreciation. The tax benefits are huge, way more than a stock return. If take into account all of the tax deductions your return is much higher. I agree with @Mike Dymski there are other metrics such as IRR which is a projection on return taken out over a certain time period. I usually use 5 years. If you invest in real estate and buy at the right price your return CoC eventually can be infinite when your cash outlay is returned through the cash flow.

    Good Luck.

    0Reply
  • Daniel Blake
    OP
    Member since 2018 · 4 posts · 1 vote
    6y

    Appreciate the help, all. @Ali Boone – currently our eyes are on north Delaware / the tri-state area. @Kenneth Garrett - the metric we are using actually is the annualized ROI we'd realize if we were to sell our property, assuming appreciation, consistent rental cash flow, closing costs, agent fees, etc. (everything we could think of basically to be comprehensive). CoC I view as a convenient metric to assess the income-producing power of the asset, but nothing more. In my eyes, the real return is what I'd get if I sold, including all the income earned and tax savings made during ownership. What I'm gathering is that I should require an annualized return of at least 20% by around year 5 of ownership, as an investment criteria, to justify all the pain in the a** that comes with small-time landlording :)

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  • Ali Boone
    Real Estate Coach · Venice Beach, CA · Member since 2012 · 6k+ posts · 3k+ votes
    6y
    Originally posted by @Daniel Blake:

    Appreciate the help, all. @Ali Boone – currently our eyes are on north Delaware / the tri-state area. @Kenneth Garrett - the metric we are using actually is the annualized ROI we'd realize if we were to sell our property, assuming appreciation, consistent rental cash flow, closing costs, agent fees, etc. (everything we could think of basically to be comprehensive). CoC I view as a convenient metric to assess the income-producing power of the asset, but nothing more. In my eyes, the real return is what I'd get if I sold, including all the income earned and tax savings made during ownership. What I'm gathering is that I should require an annualized return of at least 20% by around year 5 of ownership, as an investment criteria, to justify all the pain in the a** that comes with small-time landlording :)

    Well that's why... that area isn't known for much, if any, cash flow. There are properties in other states that will give much higher numbers. So that changes the argument.

    0Reply
  • Rumen Mladenov
    Investor · Newark, DE · Member since 2014 · 245 posts · 198 votes
    6y

    @Daniel Blake Have you looked into BRRR? If you buy a distressed property and rehab it, and then it appraises high enough that a 75% cash out refi gives you all your money back, you get cash flow at essentially 0 net investment, which gives you infinite ROI. I make it work in north Delaware where according to @Ali Boone there is hardly any cash flow, so it is definitely possible :)

    Disclaimer: I manage the rehabs and properties myself, so no PM fees and no GC cost. 

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  • Ali Boone
    Real Estate Coach · Venice Beach, CA · Member since 2012 · 6k+ posts · 3k+ votes
    6y
    Originally posted by @Rumen Mladenov:

    @Daniel Blake Have you looked into BRRR? If you buy a distressed property and rehab it, and then it appraises high enough that a 75% cash out refi gives you all your money back, you get cash flow at essentially 0 net investment, which gives you infinite ROI. I make it work in north Delaware where according to @Ali Boone there is hardly any cash flow, so it is definitely possible :)

    Disclaimer: I manage the rehabs and properties myself, so no PM fees and no GC cost. 

    There's a possibility of making a property work in any market. I was speaking more about the market(s) as a whole. And like you say, you're doing only distressed properties and you don't even have to pay a GC to work on them. Most people don't have that option. A lot of people who do know how to make it work like you do will hop on here and talk about how much cash flow and possibility there is, saying it to the masses, while never clarifying how unique or intensive it is to make that happen. It can accidentally be misleading to people. Not saying you did that.. you're one of the few who actually clarified it. So yeah, absolutely, something can work anywhere. Was just speaking as a whole.

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