Please register to participate in our discussions with 2 million other members - it's free and quick! Some forums can only be seen by registered members. After you create your account, you'll be able to customize options and access all our 15,000 new posts/day with fewer ads.
For those of you who own rental real estate, when you evaluate how your properties are doing for you, do you use cash return on investment (or cash on cash), or total return on investment that includes annual appreciation on initial investment?
I do the latter but am at odds with spouse who believes only the former should be used because appreciation is like thin air and can come and go. I believe wealth is wealth and additions to it should not only be measured in cash as in the case of cash return on investment.
Assume that this question is not being directed towards flippers but those who take a long-term hold approach in their real estate holdings.
I don't own rental property but to me it's pretty simple when figuring your return on investment. Of course the value of a home can go up or down so any gain or loss before selling would be an unrealized gain or loss. However, when you do sell, you have to take into account your rental revenue and expenses, and the sales price of your home. It's kind of like mutual funds. Think of rental revenue as dividends, your rental expenses as fund expenses, the purchase price of your home and any additions as cost basis, and the price you sell your home for as equivalent to the price you sell your mutual fund shares for. In other words, BOTH price appreciation (or depreciation) and rental income should be counted as a return on investment.
I don't own rental property but to me it's pretty simple when figuring your return on investment. Of course the value of a home can go up or down so any gain or loss before selling would be an unrealized gain or loss. However, when you do sell, you have to take into account your rental revenue and expenses, and the sales price of your home. It's kind of like mutual funds. Think of rental revenue as dividends, your rental expenses as fund expenses, the purchase price of your home and any additions as cost basis, and the price you sell your home for as equivalent to the price you sell your mutual fund shares for. In other words, BOTH price appreciation (or depreciation) and rental income should be counted as a return on investment.
Thanks for your reply. I believe total return on investment is the only way to evaluate the performance of long-term holdings.
The problem with taking into account appreciation when computing a total return on investment is that until one actually realizes the amount it is in the way of a paper profit (or loss).
For example, if one bought an investment property or any other real estate and it was purchased at what would be deemed "market value" by which I mean that if the day after buying it one could in theory sell it for the same price, one is actually down by 6% (allowing for real estate commission and other selling expenses).
So at the end of the first year would one consider the return on investment to be the cash on cash less the depreciated value of the property since it is unlikely that it would have appreciated by 6% in that first year? I would not because I don't intend selling it at the end of that first year. By the same token, if the property appreciates in value, one should not take that in to account in determining return on investment until one realizes the value upon sale.
The problem with taking into account appreciation when computing a total return on investment is that until one actually realizes the amount it is in the way of a paper profit (or loss).
For example, if one bought an investment property or any other real estate and it was purchased at what would be deemed "market value" by which I mean that if the day after buying it one could in theory sell it for the same price, one is actually down by 6% (allowing for real estate commission and other selling expenses).
So at the end of the first year would one consider the return on investment to be the cash on cash less the depreciated value of the property since it is unlikely that it would have appreciated by 6% in that first year? I would not because I don't intend selling it at the end of that first year. By the same token, if the property appreciates in value, one should not take that in to account in determining return on investment until one realizes the value upon sale.
Yes agreed- you can't pay bills with appreciation. This is especially an issue in the case of the first few years of owning a rental property- in many markets, assuming you put very little down on the mortgage (which is the right way to do it if you are aiming for high total ROI), then the market rental rate will be very close to the mortgage payments + taxes + insurance + maintenance (i.e. lawn mowing, HOA fees, gutter cleaning, etc).
Since you will be nearly cash flow neutral, if even one repair is needed you may be cash flow negative for the entire year. True- your mortgage principal is being partially paid each month, and the house is appreciating. But that won't change the fact that your cash position could decline seriously over the first few years.
As rents appreciate, you'll be more in black with each passing year. But until you're comfortably cash flow positive, the appreciation on the home isn't really doing anything for you.
I'm talking long term and owning properties for several years that produce both current rental income, have appreciated and are held debt free. I agree with the other examples given by others but that is not the case in which I posted the original question.
And for those who do own debt free, you are more likely to have access to cash via a line of credit to draw from in special situations where you have a short-term need for cash in excess of current cash reserves.
I go by income from the property against my expenses. I don't count appreciation as its a phantom value and it dies nothing for me financially. I do not borrow against the value. If I need something each property has its own cash reserve allocated
I'm talking long term and owning properties for several years that produce both current rental income, have appreciated and are held debt free. I agree with the other examples given by others but that is not the case in which I posted the original question.
And for those who do own debt free, you are more likely to have access to cash via a line of credit to draw from in special situations where you have a short-term need for cash in excess of current cash reserves.
What is the purpose of calculating this statistic. It is useful to calculate it both ways. Are you using it too compare two properties? Two different type of investments? If you are using it for the former? Then appreciation should be taken into account on some level.
However if you are comparing against other investments I disagree, because real estate is one of the most illiquid investments that exists, and as is mentioned to realize this paper gain is often times not easy.
I am not sure why anyone would not want to consider all aspects of an investment, any investment.
Please register to post and access all features of our very popular forum. It is free and quick. Over $68,000 in prizes has already been given out to active posters on our forum. Additional giveaways are planned.
Detailed information about all U.S. cities, counties, and zip codes on our site: City-data.com.
Please register to participate in our discussions with 2 million other members - it's free and quick! Some forums can only be seen by registered members. After you create your account, you'll be able to customize options and access all our 15,000 new posts/day with fewer ads.
