In the example I assume there is no mortgage because you've used your awesome mustache funds to pay in cash for the house at some point.
Bad assumption. I am in the process of buying my first place. I'm putting 20% down and taking out the largest loan I can, even though I have another 20-40% in stocks. I think my stocks will get a better return than my interest rate. I think many other people here are doing the same, if not using the other cash to buy more properties.
I will be counting the market value minus my mortgage towards the net worth.
The mortgage-free thing was just for my example. Good point about the rate of return. If the return on the rental property was higher than what could be achieved through stocks or other investment vehicles it could change the plan.
It certainly is in my case. We've got two rentals whose rate of returns are, respectively, 18% and 26% (I'm rounding). Because the rent is more than covering the cost of the mortgage (i.e. the renters are buying our house for us), I don't even count that when I calculate the ROR. I base the ROR on the following:
A: What we put into it to buy it and get it ready to rent (down payment, closing costs, renovation/spiffing up costs). This is our only actual investment, since as mentioned above the renters are paying the mortgage for us.
B: What it's bringing in per year ABOVE AND BEYOND the cost of the mortgage (in other words if the mortgage is $850 and the rent is $1850--which it is in one case (mortgage is in the $830's, for purposes of this post I'm rounding up)--then it's bringing in $12k a year).
Then divide A into B, and voila, ROR. I should probably add up maintenance costs each year, and if I did it would bring down the ROR, but not by much. That being said, I should probably also factor in the fact that the renters are buying us an appreciating asset, which would boost the ROR, but what am I, an accountant?!?! No.