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Calculating the ROI for you rental property


By BayArea   Follow   Sat, 1 Dec 2012, 5:12am PST   5,369 views   49 comments   Watch (1)   Share   Quote   Permalink   Like   Dislike  

Hi folks,

There are several different ways to approach the ROI for an investment property. Many look at the capitalization rate which is the (yearly rental income after expenses) / (total value of the property). However, for a small scale investor like myself who isn't purchasing all in cash, it's more interesting to identify ROI based on the equity or amount I'm investing up front, therefore capitalization rate loses some of it's meaning to me. I don't care what the return is when compared to the purchase price since I didn't put up the full purchase price to acquire the property.

If I am to look at the ROI of my investment property after 1 year, I need to take into account the total amount I've invested in that year (down payment, mortgage payment for the year and all associated expenses for that year) and compare it to the effective rental income. I.e. divide the effective rental income by everything I have invested during that year. Isn't that my true ROI (ignoring any appreciation or depreciation of the property)?

I'm wondering if any of you are willing to share your spreadsheet analysis on how you calculate ROI and why you use the method that you do. I have attached mine. But again, this uses capitalization rates and net returns based on the purchase price.

I'm more interested in the ROI based on the amount invested upfront. In other words:

(Net Cash Flow from rent) / (down payment + finance payment + all expenses)

And lastly for the long time investors, what ROI meets your criteria for pulling the trigger on a property?

https://docs.google.com/spreadsheet/ccc?key=0AqeJiYMCktN-dC0zcFppdFYxVnd0cWFVTlJnZ0RkMmc#gid=0

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BayArea   befriend   ignore   Mon, 3 Dec 2012, 9:41am PST   Share   Quote   Like   Dislike     Comment 10

@robertoaribas @REpro @SFace , that's helpful and thanks for sharing. Might you know why pretty much every RE ROI example out there is pre-income tax analysis? If you make $24K gross rent for example, why do most people calculate ROI when >30% of that gross rental income is going to get wiped due to income tax?

And yes, there are lots of tax deductions but they won't come close to the amount noted above, right? That's one detail nobody seems to talk about. Why?

Patrick says

If you are borrowing money to make an investment, that's using leverage.

Thanks Patrick. I understand leverage, but what I was getting at is that I'm not leveraging myself any further than anyone else who is financing their rental. Dangerous, sure. Anyone got a better alternative investment idea for my savings, lol?

Patrick says

As Warren Buffet says: the only ways that rich people get poor are "liquor and leverage".

Touche. But the only way middle class stays middle class is by taking no risks, as Mr. @Iwog once told me :-)

taxee says

Just a little counter party risk living in your depreciating asset with a pit bull and a gun. Let's hear it for the rentier class.

That will definitely get interesting... For you guys with rentals, what's your experience been in terms of being selective about your tenants? Are there any discrimination laws out there when it comes to who I rent my home out to?

stanpownall says

I expect the California market to decline further over the next five or more years as companies and people leave Califiornia.

If that happens that will be a first...

https://www.google.com/publicdata/explore?ds=kf7tgg1uo9ude_&met_y=population&idim=state:06000&dl=en&hl=en&q=california%20population

Somehow that weather and the coastal views have always kept people stretching themselves to be here.

BayArea   befriend   ignore   Mon, 3 Dec 2012, 10:15am PST   Share   Quote   Like   Dislike     Comment 11

Interesting. What is the max depreciation rate/amount that may be used in CA, anyone know?

RentingForHalfTheCost   befriend   ignore   Mon, 3 Dec 2012, 10:23am PST   Share   Quote   Like   Dislike     Comment 12

robertoaribas says

If you bought a cheap home that you could afford,

As if these people existed. Get real.

I went by a highly congested area of the bay area freeway system today in rush hour. For 55 cents you can use your fast-track to jump in the commuter lane and save yourself about 10 minutes of bumper to bumper. As I was cruising 60mph past stopped cars of all kinds (BMW, Lexus, Porche, Mercedes) it was a good reflection of what is happening. Everyone is so leveraged to get into that 1m+ home that 0.55/day is valuable to them. This can not end well folks. Stay tuned and get prepared.

David Losh   befriend   ignore   Mon, 3 Dec 2012, 11:08am PST   Share   Quote   Like   Dislike     Comment 13

Let me interject a little something that kind of got mentioned, but glossed over.

Will the property hold value?

You may be getting a great return on a property that is less than desirable. Some investors buy these with an LLC and when the going gets tough the property, or properties, go back to the bank.

That is something we experienced in 2008, 2009.

So, are you buying some one else's problem, and hoping to make it work?

Do you have an exit strategy?

When you sell, if you sell, or if you have to sell, will the value be there?

David Losh   befriend   ignore   Mon, 3 Dec 2012, 11:28am PST   Share   Quote   Like   Dislike     Comment 14

E-man says

make money when I buy

To buy what you can sell that day for a profit which includes all fees, coming in, and getting out, used to be my rule, but that has changed.

That is exactly the problem today, is what can you sell without taking a loss?

If your return on investment is only tracking the 2% appreciation figures, you're kind of screwed.

RentingForHalfTheCost   befriend   ignore   Mon, 3 Dec 2012, 12:21pm PST   Share   Quote   Like   Dislike     Comment 15

robertoaribas says

yes, you cannot discriminate based on family status, age, religion, race, color, country of origin or sex.

Just don't rent to a gay caucasian divorced 50 yr old male that preaches Scientology. His movies suck. Outside, of that do what Roberto does. Focus on the possibility of rent payment. ;)

REpro   befriend   ignore   Mon, 3 Dec 2012, 1:16pm PST   Share   Quote   Like (1)   Dislike     Comment 16

BayArea says

Interesting. What is the max depreciation rate/amount that may be used in CA, anyone know?

Depreciation is calculated on improvement value not land value, which in CA can be substantial. Example: You purchased house for $300K, land value is $120K. You will depreciate yearly $180K/27.5=$6,545, straight for 27.5 years.
Land lording is a business so most states also keep tax hand open. E.g. in CA you will pay min. $800/y to state and $150/y to San Jose city, regardless if you make a dime of profit or not.

BayArea   befriend   ignore   Mon, 3 Dec 2012, 1:36pm PST   Share   Quote   Like   Dislike     Comment 17

RentingForHalfTheCost says

I went by a highly congested area of the bay area freeway system today in rush hour. For 55 cents you can use your fast-track to jump in the commuter lane and save yourself about 10 minutes of bumper to bumper. As I was cruising 60mph past stopped cars of all kinds (BMW, Lexus, Porche, Mercedes) it was a good reflection of what is happening. Everyone is so leveraged to get into that 1m+ home that 0.55/day is valuable to them. This can not end well folks. Stay tuned and get prepared.

Perhaps. Or maybe it's because they don't know about the program. I certainly didn't until I read your post above. With $4.50/gal gasoline, I don't think those luxury car owners are as set on saving that $0.55 as you seem to think.

SFace says

From my perspective, you rent to who you want, just never say it.

That's what I was getting at. Although the laws may exist, who is going to prove that I didn't rent out my property to someone because they were black and not because of another reason like I didn't like their credit score or their reference wasn't convincing enough.

David Losh says

Will the property hold value?

So, are you buying some one else's problem, and hoping to make it work?

Do you have an exit strategy?

When you sell, if you sell, or if you have to sell, will the value be there?

I guess this comes down to whether you believe the market has hit bottom or still has a ways to fall. Most reasonable people at this point believe we are not far off from the bottom, and perhaps even have seen in in certain areas. The usual perma-bears will disagree I'm sure.

If the rent is conservatively 2x or more of my mortgage payment + prop tax, then I'm all for it, regardless of whether or not I believe that there is an appreciation upside in terms of equity around the corner. If I am cash flow positive, my risk is minimized.

Exit strategy? If I'm cash flow positive, an exit strategy isn't as critical for me.

REpro   befriend   ignore   Mon, 3 Dec 2012, 1:36pm PST   Share   Quote   Like   Dislike     Comment 18

BayArea says

Somehow that weather and the coastal views have always kept people stretching themselves to be here.

...and just before Jan.1 they should start practice: “bread is meat”, “less is more”.
No wonder why big investment firms focus investment on the smallest and cheapest houses.

REpro   befriend   ignore   Mon, 3 Dec 2012, 1:47pm PST   Share   Quote   Like   Dislike     Comment 19

My rental criteria are written on an application, period.

BayArea   befriend   ignore   Mon, 3 Dec 2012, 1:48pm PST   Share   Quote   Like   Dislike     Comment 20

Roberto, when the smoke clears I'm as fair as you are and just trying to get some perspective on the topic. Nothing more, nothing less.

BayArea   befriend   ignore   Mon, 3 Dec 2012, 2:03pm PST   Share   Quote   Like   Dislike     Comment 21

good point as vacancy can absolutely obliterate gains.

REpro   befriend   ignore   Mon, 3 Dec 2012, 2:25pm PST   Share   Quote   Like   Dislike     Comment 22

Only three states out of 50 are true champ in population growth: CA, TX & FL, where TX & FL have no state tax.
https://www.google.com/publicdata/explore?ds=kf7tgg1uo9ude_&met_y=population&idim=state:06000&dl=en&hl=en&q=california%20population#!ctype=l&strail=false&bcs=d&nselm=h&met_y=population&scale_y=lin&ind_y=false&rdim=country&idim=state:06000:48000:12000&ifdim=country&hl=en_US&dl=en&ind=false

REpro   befriend   ignore   Mon, 3 Dec 2012, 3:00pm PST   Share   Quote   Like   Dislike     Comment 23

SFace says

Partnership and sole proprietor does not have the tax since it is not separate legal entity

As long as schedule C appear in your income tax return, you are in busines. Business pay taxes.

RentingForHalfTheCost   befriend   ignore   Mon, 3 Dec 2012, 11:37pm PST   Share   Quote   Like   Dislike     Comment 24

robertoaribas says

ok, fair enough. You know, you rent to a family with small kids, they move in, the kid makes friends in the school... you could have just got yourself 5 or more years of no vacancy! worth the gamble of some spills in the house, in my opinion!

As long as you are not favoring the family with small kids. That would be discrimination against the rest of the applicants. ;)

You find me someone who truely doesn't discriminate, and I'll show you an appreciating house.

David Losh   befriend   ignore   Tue, 4 Dec 2012, 12:11am PST   Share   Quote   Like   Dislike     Comment 25

BayArea says

If I am cash flow positive, my risk is minimized.

There is a lot here in this thread that is kind of alternative universe. Small rental investors have several problems today that were low risk before 2006.

Number one rents are too damn high, and number two is that property prices have stabalized. Stabalized is very different than hitting bottom.

Property prices are propped up by massive government interference. We all know that, but ignore it. That's not perma bear talk, it's a fact, and you really have no idea where property prices will go now that the President has been re-elected, or that Congress has other things to do.

Just because you have cash flow doesn't mean you are making money. Real Estate is an over all package.

David Losh   befriend   ignore   Tue, 4 Dec 2012, 12:12am PST   Share   Quote   Like   Dislike     Comment 26

E-man says

set up a LLC

People set up LLCs so they can walk away from the property if they need to. You saw a ton on that in 2008.

David Losh   befriend   ignore   Tue, 4 Dec 2012, 1:28am PST   Share   Quote   Like   Dislike     Comment 27

robertoaribas says

rents are too high.

I don't see where inflation happened, or will happen. I see massive speculation in commodities due to these historically low interest rates, and increase in corporate profits, and massive cash reserves, but I don't see inflation.

As a matter of fact I would say, even with China moving ahead as a trading partner, that the United States is a very safe haven for money. We have a stable government, low taxes, and are very business oriented.

Where would you want your money?

What I would say is that investing in corporations may be a safer bet than housing units. I think housing is being over run by huge corporations that have plans for each community.

robertoaribas says

that is propped up?

Yes, that is propped up. In a true foreclosure market properties sell for cheap. It depends on the property, and depends on the location, but no, I don't call $80K in Phoenix cheap.

robertoaribas says

Actually, cash flow means you are making money

No it doesn't. You can cash flow all day long, and lose money.

robertoaribas says

People set up LLC's to limit their liability

Like with the mortgage. Your renter is an insurance issue, and you are pointing out correctly an LLC does very little good for the majority of people.

Sorry, Washington is a non recourse State.

BayArea   befriend   ignore   Tue, 4 Dec 2012, 7:25am PST   Share   Quote   Like   Dislike     Comment 28

David Losh says

Property prices are propped up by massive government interference. We all know that, but ignore it.

Do you know who just got re-elected? Mr. Artificial Prop himself. Sure, prices are being propped up to some degree, but that's not changing anytime soon. So what's the other thing that can have a heavy handed influence on prices? Interest rates. I can't see those budging much either.

I'm not sure I stand to gain much by waiting around for artificial props to subside, our accounting laws to change forcing banks to unload foreclosures right away or realize loses immediately, or for interest rates to rise...

David Losh   befriend   ignore   Tue, 4 Dec 2012, 8:00am PST   Share   Quote   Like   Dislike     Comment 29

BayArea says

Do you know who just got re-elected?

President Barrack Obama just got re-elected, and he is the one that saved our economy by borrowing massive amounts of money.

Well, I think the long term strategy is to get the Republicans out of the House, and have a super majority that can fix a lot that went wrong.

One of the things that went wrong was banks having control of the housing market.

The shift is, with our government buying up Mortgage Backed Securities at the rate of $40 Billion per month, soon to be $80 Billion per month, control of the housing market transferring to the government.

You don't like it? You say you would rather have banks dictate the terms of the housing market?

Well, get used to it.

Corporations will play nice, money will be made, and housing will go back to that sleepy little payment you make each month for a place to keep your crap.

RentingForHalfTheCost   befriend   ignore   Tue, 4 Dec 2012, 8:10am PST   Share   Quote   Like   Dislike     Comment 30

robertoaribas says

6 more years like that, and i'll have precisely $0 of my own money out there, and still own the properties... care to explain the big risk of that to me?

The risk of not getting 6 more years like that. ;) 1 year of a gov't that doesn't buy its own bonds to pay itself and your properties lose 25% and you have a hell of a tenant retention problem. Add to it, your properties tax bill keeps coming, as well as maintenance. There is always risk, the trick is to manage it. From your writings, I think you have managed yours well, but that doesn't mean you are not worried. I know many bay area owners/investors that were not so smart.

Mobi   befriend   ignore   Tue, 4 Dec 2012, 10:16pm PST   Share   Quote   Like   Dislike     Comment 31

David Losh says

The shift is, with our government buying up Mortgage Backed Securities at the rate of $40 Billion per month, soon to be $80 Billion per month, control of the housing market transferring to the government.

The entity who buys the $40 billion MBS per month is called Fed, which is a semi-government BANK. Don't you know their committee are mostly made of bankers? At this point, the interests of the federal government and the big banks are so interwined so I won't bother to seperate them.

David Losh   befriend   ignore   Wed, 5 Dec 2012, 12:33am PST   Share   Quote   Like   Dislike     Comment 32

Mobi says

the interests of the federal government and the big banks

Yeah, banks have relied on governments globally to continue those profits. We all borrow money. Our government is borrowing money to buy Mortgage Backed Securities.

Who's in charge now?

Banks have run rough shod over the global economy for thirty years, and from my point of view they cashed out in 2008.

I look at Barrack Obama as a smart guy. He could have crashed the economy, blamed the Republicans and put us into default. He didn't. He borrowed, and every body was happy to play along. Barrack Obama has propped up the entire banking system ever since, but it means nothing to what is coming.

Consumer debt is neck, and neck with our federal deficit. Consumer spending makes the world go around. There is no China without consumer spending. Europe is trashed, Russia is suffering, and those emerging markets are getting hip to the fact they will never be able to repay what they have borrowed.

What's a banker to do?

The bank will play ball with whatever hair brain idea Obama comes up with next. I think that housing will languish as other things take a bigger role in our economic future. People will get a chance to pay off debt, and banks will agree with that as a survival mechanism.

Mobi   befriend   ignore   Wed, 5 Dec 2012, 1:13am PST   Share   Quote   Like   Dislike     Comment 33

robertoaribas says

you don't know what you are talking about... People set up LLC's to limit their liability, say a tenant gets hurt and sues them, the tenant is renting from the LLC, and could only attach the one property. (unless they pierce the corporate veil, which is much more common than the llc gurus talk about)

Very interesting comment here. Obviously, landlords try to set up LLCs to limit the liability. But let's say you have a house under a LLC and you still go into the house to do repairs YOURSELF. If something happens and the tenant takes the legal action, can you really shield yourself through the LLC?

Mobi   befriend   ignore   Wed, 5 Dec 2012, 1:18am PST   Share   Quote   Like   Dislike     Comment 34

David Losh says

The bank will play ball with whatever hair brain idea Obama comes up with next. I think that housing will languish as other things take a bigger role in our economic future. People will get a chance to pay off debt, and banks will agree with that as a survival mechanism.

I kinda agree with you. They still work with each other now but time will come when government wants to take full control and use some unorthodoxical methods to "solve" the problem (before it melts down) and banks will have to go with that. But I am not as optimistic as you that they will make the "right" choice. I guess we will find out.

FortWayne   befriend   ignore   Thu, 6 Dec 2012, 1:04am PST   Share   Quote   Like   Dislike     Comment 35

Just be careful with your depreciation deductions, they do have to be legitimate.

FortWayne   befriend   ignore   Thu, 6 Dec 2012, 1:06am PST   Share   Quote   Like   Dislike     Comment 36

Mobi says

Very interesting comment here. Obviously, landlords try to set up LLCs to limit the liability. But let's say you have a house under a LLC and you still go into the house to do repairs YOURSELF. If something happens and the tenant takes the legal action, can you really shield yourself through the LLC?

It will not protect you from a lawsuit. Having an LLC does not give a person free reign to do as they please. Members of any Limited Liability type of enterprise are still held responsible for their own actions, especially the owners/directors of an LLC since they are responsible for all the debt of the venture even in case of bankruptcy.

The limited liability part here is only if you are a small shareholder, your liability is only what you put into the company. For example Roberto creates an LLC, and you come in as a minority partner and invest 5,000 into it... you'll only be liable up to 5,000 if the LLC screws up. If you do something bad on your own, that limit no longer applies.