Relationship of Principal and ROI

[Jim D.]

As I understand it, ROI = (Cashflow per Month * 12) / (Total Equity)

I'm having trouble understanding why principal doesn't count towards monthly income in this equation. For example:

I buy a rental for $100,000 with a $2,000 Down Payment. Total cashflow is 0. Therefore, my ROI = 0%.

However, during my first year of ownership, the $2,000 I invested doubled to $4,000 because my tenants' rent has been paying the principal on my loan. Isn't this a 100% ROI? My $2,000 made me an extra $2,000.

Can someone clear this up for me? Thank you.

[Vikram C.]

Your ROI formula is wrong and perhaps that's why you are confused. The first year's cash flow from the property is often referred to as "cash-on-cash" return and you have confused that with ROI.

The ROI on a multi-year investment is actually not that simple to calculate, but it would take into account the reduction in your loan balance.

BTW, I am not sure from where you got the $2,000 investment figure when your example mentions a $5,000 down payment.