Real Estate Investor · Glen Allen, VA · Member since 2008 · 74 posts · 43 votes
In talking to people and reading various posts online, I see a lot of confusion and varying opinions on ROI vs. ROE vs. IRR vs. Cash on Cash. For example, some people think that in the first year when you purchase the property, ROE (return on equity) and Cash on Cash are the same. The reasoning goes that your initial equity in the property before you see any appreciation or debt amortization will be equivalent to your cash investment, i.e. downpayment. While this can be close, at times, it almost never will be exactly the same. I can think of 2 reasons:
1) Not all of your cash investment into a deal will end up being equity. Your downpayment, yes, but not your closing cost (including points, legal fees, appraisal, etc). So your equity initially will be less than your total cash investment, leading your ROE to actually be higher than your cash-on-cash return.
2) If you are buying a property below market value, your equity from day 1 will be higher than your cash investment, leading your ROE to actually be lower than your cash-on-cash. The difference even in year 1 can be quite large.
Another thing I see quiet often is people differentiating between ROI and cash-on-cash return. I’ve seen all sorts of explanations. My take on it is that they’re basically the same. Cash-on-cash calculates your return on cash invested in to the deal. ROI (return on investment) can be calculated in many ways, but in my book it calculates the same thing â€" how much money am I earning on my cash invested into the deal. One deviation for ROI that I often encounter which makes sense to me is when figuring in the proceeds from resale of the property (this is when you monetize your amortization and appreciation and can calculate the $ benefit of both as a % of your original investment). I also call that calculation a “cumulative cash-on-cash returnâ€, which you can then annualize to get to a true return %.
I'd love to hear your opinions, especially differing ones.
Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
16y
Dan, you have some Enron accounting going on here.....you said your equity would be higher if you acquired a property at a discount or below market. That can not happen by definition, that thinking comes from TV gurus who lie.
The value of your property is what you paid for it, regarless of what your preceive the value to be. Now, after a year (in an new accounting period) your assets are valued at the LOWER OF COST OR MARKET, WHICH EVER IS LESS. Now, for mortgage financing, you use the current market value after one year, within a year, it's based on your cost.
As to analysis, look to the return on your cash as it may reflect a truer picture. In sub 2 or wraps, you may earn a return over the underlying loan under your contract. Such a deal requires a little weighted average analysis.
People who like to punch buttons on financial calculators like to look at ratios. From a financial aspect, most investors do not know what their real cost of capital is or what the over the hump rate is, or your opportunity costs, so you don't have a basis to compare to! It means nothing, it's just fun to do and it might bring a smile to your face, but from a financial business standpoint, meaningless. The same thing with a capitalization rate, you need to know what your cost of capital is and what alternative investment rates are before you can have an accurate rate. To keep a smile on your face, just look at how much cash you had to put into a deal and what you walk away with, much easier. Bill
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
Nice post Charles...I don't understand how anyone that does distressed real estate purchases for a living or for a business can think that the purchase price is automatically equivalent to the market value. It is quite strange to me.
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
15y
There has been too much back and forth for me to figure out here so in an effort to start over fresh and CLARIFY:
The argument/contoversy IS: Price one pays = current market value, period, Vs. one can buy below current market value.
Assuming this is the correct debate as I understand it, can we please forget about accounting, MBA, GAAP, and all the other legal and governmental things brought up, they all just keep taking us off course here.
Going directly off of dthe debate as I have written it above, you are either on one side of this debate or the other. Whichever side you are on, and forgetting about the GAAP and all the other stuff mentioned - support your side WITHOUT reference to accounting, GAAP, etc. with real world examples.
I am on the side that one can purchase below current market value for the following reasons:
I do it every day.
I have bought and sold properties on the very same day for higher sale prices and pocketed the difference, the only explanation to that is that I purchased BELOW market value (actual, not perceived), because my purchaser paid an ACTUAL amount higher than I did for the very same property.
In other scenarios, I purchase REO's from banks (distressed assets) who are MOTIVATED sellers. These motivated sellers are willing to sell below current market value for a number of reasons and being the savvy buyer I am, I take advantage of that. I then make repairs and force appreciate the property, then sell for even more. Even if you argue that the money I invest to rehab = double in the price I get on the sale end, I still have a larger profit margin and the only explanation to that is that I purchased below market value (actual and perceived).
Ever heard of the saying that savvy investors make their money on the purchase and not the sale? This derives from the fact that a savvy investor or good negotiator can convince a seller to sell their asset below the going current market value. The paycheck does not come, obviosuly, until the sale, however, the profit was negotiated on the purchase, not the sale.
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
15y
Bill- I often agree with many of your posts, but have no idea how you are on the opposite side here.
Eddie - I have no idea how you believe that market value is whatever you pay for a property either. This really surprises me coming from you. I would think that you are aware dthat you, me, and many others are capable (and actively do so) of buying RE at discounts to current market value.
Or, perhaps I am missing your positions.
Perhaps you both can explain your position clearly leaving out the GAAP, accounting practices, laws, and appraisal issues.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
Again Will...the position is obviously ridiculous. It would be nice for the people taking it to own up to how ridiculous it is. Instead they double, triple, etc. down and come up with some wild Three-card Monte responses riddled with half insults, revisionist rhetoric, and goofy scenarios to explain how they weren't wrong.
The chances of them owning up to their mistake(s) are lower than winning the Powerball twice in a year so it really does not good to beat it to bloody death anymore. They have admitted they were wrong by changing their position in the thread and this should be completely obvious to anyone reading it or anyone with some common sense about distressed investing.
Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
15y
It is clear to me that some can purchase below actual market value and therefore have immediate equity. When a seller is put into a position where they must sell in an imperfect market and the only qualified buyer is an investor that can take or leave the property there is very good chance the property will sell under actual market price. What the actual market value is IMO is unknown and could only be estimated. To say that the price paid was the market price is no better estimate than to say the price is $X higher that what was paid.
I understand why a bank might want to use the price paid as market value, but even that isn't fully accurate because if an appraisal comes back that is less than the purchase price the bank is not going to be willing to say the purchase price is the market price.
Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
15y
Good morning, well this is really an easy concept to grasp if we begin by accepting the definition of market value. We can leave all the givernment, reguluatory and legal aspects out of the basis to accept the definition, I hope, and just accept it.
[i]IF your transaction meets the requirements of the definition, then the price at which it seels is the market value, what it sells for is the market value regardless of your perception of value. The question to ask is did mt transaction meet the definition? Was it marketed for a reasonable time period (30 to 90 days) were both parties aware of all significant issues concerning the propety, were there any seller concessions, like adjustments to the price for damages and if they were, were such adjustments reasonabale and did they fairly reflect the costs of repair? Were both parties acting in their own best interest? Was consideration paid in cash or its equivilant? ETC.
If these conditions were present in your transaction, then you purchased the property at its market value.
If these conditions were not present in your transaction, the price paid does not reflect the market value. You could pay more or less than market value. Buying below market value is what investors attempt to do and do as pointed out. That price paid is, most often the market value, but sometimes the definition is not met and therefore, it is not purchased at market value.
This is the very first aspect of performing any appraisal. When I appraised real estate the very first order of business was to view the transaction and determine if the definition of market value was met in the transaction, if the property had been marketed sufficiently, if there were seller concessions, if adjustments for repairs were valid, etc. If there were aspects of the transaction that did not meet the definition, then those had to be adjusted and if they were significant, comments were then required to inform the client. This holds true with not only the subject, but also with comparable propertiers.
To say that I purchased below market value and made 10K without selling the property is not a true statement. This has been my point all along from my first post. Until you sell the property you have not "made" anything.
If you were really to claim an immdeiate profit, in order to balance your books, you would have to recognize the income, at which point you would have taxable income on your books. But investors certainly don't do that, that I know of, as they would prefer not to pay taxes on a preceived gain not paid in hand.
So, it appears to me that some want it both ways, say they made money without really claiming it when it's time to crack that nut.
My objection to recognizing income before it is received is simply based in accounting principles and to dispute those priciples is ridculous. Only in pro forma analysis would unrecognized income be considered and mixing actual and anticipated income together is totally incorrect.
Not only from an any acceptable accounting stand point but from any logical system that can have any accuracy at all.
Any time you see gurus or investors claiming they made money from an equity is a red flag. This practice inflates net worth based on an opinion of value and can not be relied upon by any PRUDENT lender or investor. Many investors get taken when they "buy-in" to some inflated valuation.
Gurus use artificial vaulations as a basis to show how you can get rich quick. Shister investors pledge such properties with inflated values to cash investors and other shams are sales of properties with rent-to-own buyers in place. This is obvious and common knowledge.
Wait til some "wheeler dealer" buys a property for 12K then assigns that property for a loan to some little old lady for 25K and fails on the deal. Then you'll find out about claiming false equity can get someone hammered. There was a group here in town doing exacly that and the AG now has fraud charges against them!
Now, as Charles pointed out, I don't have a problem with recognizing equity in a conservative and prudent manner and this can be done by an independent appraisal, not from comps pulled by that individual investor who benefits from the analysis. Larger corporate entities have different issues than real estate investors where accounting for equities is prudent, like in invenotry valuations with periods of inflation. Real estate markets don't usually move fast enough to justify such adjustments.
So, hope the differences in my comments have been made more clear with all of this. My saying the price you paid for a property being the market value is dependent on meeting the definition of market value. Not an incorrect statement, but neither is saying that it is possible to buy at a price that is not the market value or what the market value might be as proven when it sells. Just because you buy a property at a good price does not mean you bought below the market value.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
Originally posted by Financexaminer:
The value of your property is what you paid for it, regarless of what your preceive the value to be.
I don't see any qualifiers in the passage above Bill. Now you have conveniently spun a whole new position....nice job! I am glad you realized your position was incorrect and owned up to it.
My Enron accounting degree at the newbie student institute says differently so I'll go with what they say. :wink:
Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
15y
Never changed a thing, my intent has remained constant, the spin is from your end claiming there is one. I think that pretty well sums it up, so I'm done, people either get it or they don't. Good luck.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
Originally posted by Financexaminer:
Which is not intended as a slam or to insult you, but you are way off here. The reason you can not convince a bank of this preceived equity is because it does not exist.
It seems pretty crystal clear to me what your initial position was. I think it will to any subsequent readers too.
Why not just admit that you are wrong and move on? It would sure save a lot of back and forth. It's okay...everyone makes mistakes!
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
Originally posted by Financexaminer:
Dan, you have some Enron accounting going on here.....
Originally posted by Financexaminer:
Bryan, I like your suit and obviously you read a book to know about a manager's internal rate of return, but your further description of bookkeeping leads me to believe that you may not have, let's say, an advanced knowledge of accounting.
Originally posted by Bryan Hancock:
From a true accounting standpoint these comments may be true, but I would argue they are inaccurate from a finance standpoint....I respectfully disagree.
Originally posted by Financexaminer:
The only real problem with Enron accounting is that it misleads investors.
Originally posted by Financexaminer:
Now that we have about 100,000 viewing the site, let'sbump it up. Maybe there are some professionals with experience in business that can convey this better than I can to those who are still students. I have better things to do.
Originally posted by Bryan Hancock:
No worries Bill...we can agree to disagree.
Again...just my opinions. A difference of opinion is what makes a market a market...right?
Originally posted by Bryan Hancock:
It seems you just want to argue for argument's sake. Believe what you want to. The accounting matters not when you have ACTUAL cash flows to look at to determine realized compound yields, IRRs, or whatever numbers ACTUALLY happen.
Got it Bill...I am the one being antagonistic. Take a look at the passages above.
It think it is quite obvious you were wrong about your initial position in this thread. People can recognize it for themselves so there is no need to harp on it.
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
15y
After my best efforts to clarify and cut to the chase of this back and forth stuff, I must have failed.
@Bill - The debate was and IS can one buy "below market value" or "price you pay is market value". Again you spun off on if a transaction meets a definition. I certainly can care or less about definitions here as they relate to accounting and financing positions. As previously stated, I wanted to keep that out of the debate to keep it simple.
If certain conditions are met, as you stated, then it meets the definition of market value:
Originally posted by Financexaminer:
IF your transaction meets the requirements of the definition, then the price at which it sells is the market value, what it sells for is the market value regardless of your perception of value. The question to ask is did mt transaction meet the definition? Was it marketed for a reasonable time period (30 to 90 days) were both parties aware of all significant issues concerning the propety, were there any seller concessions, like adjustments to the price for damages and if they were, were such adjustments reasonabale and did they fairly reflect the costs of repair? Were both parties acting in their own best interest? Was consideration paid in cash or its equivilant?
So, you have just stated that under the definition and conditions, a sell price is the market value, but you also stated that if these conditions do not exist, then it is possible to purchase below market value. This is my point all along, any investor CAN buy below market value . . end of story.
Regardless of all the rest tossed into the middle here, you stated that it is possible, therefore you agree that buying below market value is obtainable.
You also stated that:
And I agree 100%. I think (speaking for Bryan) that he would agree 100% as well. I do not recall either of us ever stating we count profit before we sell. Profit can ONLY occur when a check is cashed and as such, until you sell the home, the "equity" remains sitting in the walls of the home and that very eqity can diminish over time (depreciation) or increase (appreciation).
I don't think any of us have an argument to this. It is black and white, no grey areas. Agreed?
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
We can beat the dead horse a few more times. If you go back to the part of the thread 9 or so months ago you will find that I claim that IRR is the only true measure because all other measures are subject to abuse and inaccuracy. It is hard to abuse real world cash flows. Bill wanted to argue with me for some reason and this was the genesis or many other stupid arguments for months afterwards where it was clearly demonstrated he was wrong.
You can spin your way to a whole new position by parsing the definition of market value in an effort to prove you weren’t wrong. Most will see through this charade though. Some won’t and that is okay too. It really doesn’t matter at the end of the day. All that matters is that future readers realize that the purchase price and market value are NOT NECESSARILY the same.
Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
15y
I agree with Will's last post. We do buy below market value for a number of reasons - mainly due to distressed sellers. Bill posted that under distressed conditions, one is not buying at market value - and I can agree with that too!
And I would never claim I "made" money just because I bought below what I considered to be market value; I simply gained equity. I can go to a bank and obtain financing to possibly tap some of that equity, so at that point I am able to realize some money from the property that I purchased below market value; no need to sell IMO to get at money with this approach.
Seems people in this thread are taking offense to being called "wrong", so I've refrained from doing so in this post. :D
Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
15y
Originally posted by Steve Babiak:
I agree with Will's last post. We do buy below market value for a number of reasons - mainly due to distressed sellers. Bill posted that under distressed conditions, one is not buying at market value - and I can agree with that too!
And I would never claim I "made" money just because I bought below what I considered to be market value; I simply gained equity. I can go to a bank and obtain financing to possibly tap some of that equity, so at that point I am able to realize some money from the property that I purchased below market value; no need to sell IMO to get at money with this approach.
Seems people in this thread are taking offense to being called "wrong", so I've refrained from doing so in this post. :D
Wrong? No, sorry, but Steve you get it. You didn't buy under the "market value" (if it did not meet the definition) and you can't really say what your "equity" is until you sell it, otherwise it's nothing but a guess. My thing was those who were saying they "made" money instantly, like the gurus claim. As for borrowing the equity, you certainly can, if your loan is from a bank, you will usually need to own it for one year before you cash out and that will be based on an Estimate of Market Value (it still is not a sale, but an estimate the bank will use to set the LTV)
No problem. And, my comments were really not so much about financial analysis, unless you used a "market value" improperly, which most investors do. Most investors never started out learning the difference between market value and price and really could care less, I understand that. But when you throw terms around to justify a basis for profits that are unrealized, by definition, it is wrong. You'll probably only get this opinion from an appraiser, not a residential investor. No one has to say they are wrong, especially me on what I just said, lol, but if I were wrong, I would say so!
I'll address this issue again, but not in this thread. Sale Price or Transaction Price and Market Value ARE NOT necessairly the same thing. :roll:
Real Estate Investor · Glen Allen, VA · Member since 2008 · 74 posts · 43 votes
15y
Looks like I've created a moster with this thread. But despite some animosity, this has been a great discussion. I deal with a ton of residential investors in my business and very very few people understand these concepts - forget fully - not even remotely.
Now everyone here needs to hug it out and move on :)
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
15y
I too tried to avoid the "you're wrong" approach and was asking for clarifications on positions. Who is right and who is wrong is not of importance, what is important is that we can clarify a position and back it up with relevant facts. Hopefully I did that for my position which remains, anyone can purchase below market value and realize gains only after the re-sell. Even with a cash out refi 12 months later, gains are not necessarily made as equity can vanish over time, the only true profit comes from the sale.
Originally posted by Financexaminer:
My thing was those who were saying they "made" money instantly, like the gurus claim.
I agree Bill, such claims are hogwash, but can you point where in this thread anyone of us contributors debating "buying below market value" stated such nonsense?
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
Originally posted by Will Barnard:
I agree Bill, such claims are hogwash, but can you point where in this thread anyone of us contributors debating "buying below market value" stated such nonsense?
You won’t find it. What you will find is someone emphatically stating that the purchase price IS the market value though and berating someone because they disagreed with THIS hogwash.