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.  If this video interests you, there are a lot more like this one in our Learning Center.  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.

The Assumptions

In this simple example there are several assumptions that just don’t apply in reality.  Let’s look at them.

Market Appreciation

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”?!!

Closing Costs

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!

Timing

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