Author Topic: Confused - ROI stocks vs real estate  (Read 1258 times)

cube.37

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Confused - ROI stocks vs real estate
« on: February 20, 2017, 12:31:49 AM »
Hi all. My wife and I are exploring the housing market because we are aiming to purchase our first investment home by the end of the year.

I was running some numbers on the houses we looked at today and was getting confused on whether or not I could directly compare the ROI number used in real estate investing and ROI when talking about stocks.

ROI in stocks is very simple: (Final Amount - Initial Investment)/Initial Investment.

However when it comes to real estate, I'm getting confused on whether or not I'm supposed to subtract the closing costs from the Final Amount calculation. In the online examples I've found, the closing costs included in the Initial Investment amount is also included in the Final Amount. However, I'm thinking it shouldn't be included because the closing costs aren't anything you'll be getting back.

For example, lets use the following numbers:
Downpayment = $200k
Closing costs = $5k
(cash outlay = $205k)
1st year Cash flow, equity, appreciation = $10k

Wouldn't it make more sense for ROI to be calculated like this?:
(($200k+10k)-($205k))/$205k.

This would give it a return of 2.4% rather than 4.9%


Any help explaining why 4.9% is the commonly used answer would be very helpful. Thank you!
« Last Edit: February 20, 2017, 12:35:55 AM by cube.37 »

SeattleCPA

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Re: Confused - ROI stocks vs real estate
« Reply #1 on: February 20, 2017, 06:42:49 AM »
Your 2.4% number is right. At least if you look only at the first year.

Look at what happened... You "lost" $5K of value because what you bought for $205K is only worth $200K... And then you earned operating income of $10K.

BTW, the project or property rate of return for real estate equals the appreciation rate (in your case nearly minus 5%) plus the income capitalization rate (in your case almost 10%).

Here is the actual math: income capitalization rate or cap rate $10/$205... or 4.878%

Appreciation rate -$5K/$205 ... or -2.439%

4.878% - 2.439% = 2.439%

cube.37

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Re: Confused - ROI stocks vs real estate
« Reply #2 on: February 20, 2017, 08:04:30 PM »
That's very helpful. Thank you!

Kalergie

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Re: Confused - ROI stocks vs real estate
« Reply #3 on: February 21, 2017, 03:18:37 AM »
What about the opportunity cost of the downpayment which could have been invested in the stock market?

Car Jack

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Re: Confused - ROI stocks vs real estate
« Reply #4 on: February 21, 2017, 08:44:52 AM »
I'd also do an honest estimate of time working on the real estate and put some number on it ($25 an hour).  I always remember that in the stock market, I literally do nothing and money comes in.  For real estate, I have to do something.  If I didn't own the real estate, I would not go volunteering to help some other landlord for free so when estimating if I'm making anything, I'd put a number on my time and a dollar value to that.  I've done other things that I really like doing (parting out junk cars, building guitars) that I have put $ on my time.  I would do them for free, so the nickle an hour I make is fine.  But if I were being paid a nickle an hour to argue with a tenant at 3 in the morning because the police called me for a disturbance the tenant was causing, I'd be pretty not-happy.

SeattleCPA

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Re: Confused - ROI stocks vs real estate
« Reply #5 on: February 22, 2017, 02:17:04 PM »
I'd also do an honest estimate of time working on the real estate and put some number on it ($25 an hour).  I always remember that in the stock market, I literally do nothing and money comes in.  For real estate, I have to do something.  If I didn't own the real estate, I would not go volunteering to help some other landlord for free so when estimating if I'm making anything, I'd put a number on my time and a dollar value to that.  I've done other things that I really like doing (parting out junk cars, building guitars) that I have put $ on my time.  I would do them for free, so the nickle an hour I make is fine.  But if I were being paid a nickle an hour to argue with a tenant at 3 in the morning because the police called me for a disturbance the tenant was causing, I'd be pretty not-happy.
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