Annualized Total Return on Rental Property Calculator

9 Replies

I need some clarification regarding the "Annualized Total Return" number that is calculated in the Rental Property Calculator as follows:

Formula used: ((Ending Value / Beginning Value) -1) / Years; 

However, in my 10 years of experience in finance and investments plus during my formal education (MS in Finance) I have always learned that the annualized return formula looks as follows:

((Ending Value / Beginning Value) ^ (1/Years)) - 1

In earlier years the delta between the two formulas is somewhat negligible; However, in later years (approx. after five years); the delta is getting quite substantial. 

So can somebody please explain why we use the first formula (above) instead of the widely acceptable second formula? Is this something specific to real estate?

Thanks,

Andreas

Can you show solid numbers why this is significant?

I'm not great w spreadsheets, and have usually relied on the available forms to crunch the numbers myself.

What is the difference in the long run? RE is going to change, rentals will go vacant, repairs will be more and things will come up which skew the original projections.

Thanks for your input and help. I'd like to know as well.

See table below to refer to the delta between the two formulas. As you can see in later years we are talking about a delta from 2x all the way to over 3x difference. 

And these numbers include everything from vacancy rates to all the costs, to the sale fees in a potential sale scenario. 

Anybody have some inputs?

Thanks,

Andreas

PS: This is not an actual project I am pursuing - just a test object.

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Year 12 Year 13 Year 14 Year 15 Year 16 Year 17 Year 18 Year 19 Year 20 Year 21 Year 22 Year 23 Year 24 Year 25 Year 26 Year 27 Year 28 Year 29 Year 30
Total Annual Income: $28,800 $29,088 $29,379 $29,673 $29,969 $30,269 $30,572 $30,877 $31,186 $31,498 $31,813 $32,131 $32,453 $32,777 $33,105 $33,436 $33,770 $34,108 $34,449 $34,794 $35,141 $35,493 $35,848 $36,206 $36,568 $36,934 $37,303 $37,676 $38,053 $38,434
Operating Expenses: $15,072 $15,223 $15,375 $15,529 $15,684 $15,841 $15,999 $16,159 $16,321 $16,484 $16,649 $16,815 $16,984 $17,153 $17,325 $17,498 $17,673 $17,850 $18,028 $18,209 $18,391 $18,575 $18,760 $18,948 $19,137 $19,329 $19,522 $19,717 $19,914 $20,114
Mortgage Payment: $16,443 $16,443 $16,443 $16,443 $16,443 $16,443 $16,443 $16,443 $16,443 $16,443 $16,443 $16,443 $16,443 $16,443 $16,443 $16,443 $16,443 $16,443 $16,443 $16,443 $16,443 $16,443 $16,443 $16,443 $16,443 $16,443 $16,443 $16,443 $16,443 $16,443
Total Annual Expenses: $31,515 $31,665 $31,817 $31,971 $32,126 $32,283 $32,442 $32,602 $32,763 $32,927 $33,091 $33,258 $33,426 $33,596 $33,767 $33,941 $34,116 $34,292 $34,471 $34,651 $34,833 $35,017 $35,203 $35,390 $35,580 $35,771 $35,965 $36,160 $36,357 $36,556
Total Annual Cashflow: $(2,715) $(2,577) $(2,439) $(2,299) $(2,157) $(2,014) $(1,870) $(1,724) $(1,577) $(1,428) $(1,278) $(1,127) $(973) $(819) $(663) $(505) $(345) $(184) $(22) $142 $308 $476 $645 $816 $988 $1,163 $1,339 $1,517 $1,696 $1,878
Cash on Cash ROI: -6.56% -6.23% -5.90% -5.56% -5.22% -4.87% -4.52% -4.17% -3.81% -3.45% -3.09% -2.72% -2.35% -1.98% -1.60% -1.22% -0.84% -0.45% -0.05% 0.34% 0.75% 1.15% 1.56% 1.97% 2.39% 2.81% 3.24% 3.67% 4.10% 4.54%
Property Value: $346,800 $353,736 $360,811 $368,027 $375,387 $382,895 $390,553 $398,364 $406,331 $414,458 $422,747 $431,202 $439,826 $448,623 $457,595 $466,747 $476,082 $485,604 $495,316 $505,222 $515,327 $525,633 $536,146 $546,869 $557,806 $568,962 $580,341 $591,948 $603,787 $615,863
Loan Balance: $284,338 $278,970 $273,387 $267,581 $261,542 $255,262 $248,730 $241,938 $234,874 $227,527 $219,886 $211,940 $203,675 $195,081 $186,142 $176,846 $167,178 $157,123 $146,666 $135,791 $124,481 $112,718 $100,485 $87,763 $74,532 $60,771 $46,460 $31,577 $16,098 $0
Equity Value: $62,462 $74,766 $87,424 $100,446 $113,846 $127,633 $141,823 $156,426 $171,458 $186,931 $202,861 $219,263 $236,151 $253,542 $271,453 $289,901 $308,904 $328,481 $348,650 $369,431 $390,846 $412,915 $435,660 $459,106 $483,274 $508,191 $533,881 $560,372 $587,689 $615,863
Total Profit if Sold: $(12,815) $(3,712) $5,871 $15,945 $26,525 $37,623 $49,253 $61,429 $74,167 $87,480 $101,386 $115,900 $131,038 $146,819 $163,260 $180,380 $198,197 $216,732 $236,006 $256,038 $276,851 $298,469 $320,913 $344,209 $368,382 $393,457 $419,462 $446,424 $474,373 $503,337
Annualized Total Return (Standard Formula): -30.99% -4.59% 4.52% 8.50% 10.42% 11.39% 11.86% 12.05% 12.09% 12.04% 11.92% 11.77% 11.61% 11.43% 11.25% 11.07% 10.89% 10.71% 10.54% 10.37% 10.20% 10.05% 9.90% 9.75% 9.61% 9.47% 9.34% 9.21% 9.09% 8.97%
Annualized Total Return (BP Rental Calculator Formula): -30.99% -4.49% 4.73% 9.64% 12.83% 15.16% 17.02% 18.57% 19.93% 21.16% 22.29% 23.36% 24.38% 25.36% 26.32% 27.26% 28.20% 29.12% 30.04% 30.96% 31.88% 32.81% 33.74% 34.68% 35.64% 36.60% 37.57% 38.56% 39.56% 40.58%

Your traditional method is compounding annualized return, assuming each year's return is a function of the previous year's principal, which is not the case. Your "standard formula" returns are lower because the rate of return is imposed on a larger present value each year.

You engage in one purchase, one sale of a property. Use the simple arithmetic mean.