by Peter Nelson 3/27/2018 How to calculate the astronomical return on investment (ROI) from rental real estate!
How Rental Real Estate build wealth
It was 1989 and I was laying in bed thinking about the real estate I owned. Real estate in Bend, OR back then was appreciating at the rate of 18%/annum. I knew I was making a lot of money (on paper), but I was curious what my return on investment (ROI) was. So I made up a simple example to help me calculate. I will share it here with you in this video. The results dumbfounded me! It took me two weeks to actually believe I had it right.
The ROI Example
So there I am lying in bed (without paper and pen). So I made up this example and kept it real simple to keep the numbers straight in my head. Assume back then I purchased a $100,000 home (which, back then, wasn’t that far off from reality!). I put $10,000 down and got a mortgage for $90,000. At the end of one year I decide to sell the property. For simplicity sake, assume there are no real estate commissions or other closing costs.
I sell the property for $118,000. I pay the bank back their $90,000 and I keep…huh? What? $28,000? You mean I get my $10,000 back AND another $18,000? That, my friends, is called a 180% ROI!!! I couldn’t believe it. I got up the next morning and re-did the calculations because I knew I had done something wrong. For 2 weeks I still wouldn’t believe it. I finally came around.
In this simple example there are several assumptions that just don’t apply in reality. Let’s look at them.
First off, 18%/annum market appreciation is unheard of. (Those were some mighty times for Bend, OR!) A more realistic figure might be 8%. If you run through the numbers again you would have gross proceeds of $108,000, net proceeds of 18%, and a ROI of 80%. Ummm, can you say “astronomical”?!!
We all know the real estate agents get paid a commission — usually up to 6%. Plus there is title, escrow, excise taxes, etc. Our simple example did not take those into account. But when you are seeing a theoretical ROI of 80-180% there is plenty of room to pay the others!
Few people buy real estate and sell it one year later. Real estate is a long-term play which requires long term thinking to be successful at it. The good news is that appreciation has a way of compounding. So the 6% rise this year is on top of the 8% rise last year and the 5% rise the year before, if you catch my drift. The compounding makes our simple example even better if you hold for multiple years and do not sell