10 June 2008
Return on Investment: How much is enough
When I thought about the term “Return on Investment” or ROI, for some reason I thought about lottery tickets. Investing is a lot like a lottery ticket. If you buy enough, you’re probably going to get a return, but you just don’t know for sure how much. Now hopefully your returns on investments are a little more secure than a lottery ticket, but in a way, they are similar.
(Personal Anecdote – Skip if you only care about true investments)
One day, when I was in another part of town waiting for some family members to meet me, I stopped at the gas station. The two customers in front of me both bought scratch-off lottery tickets. When in Rome…plus I was bored, so I plunked down a five dollar bill and asked for five $1.00 tickets. I returned to my car and scratched them all, excitedly to find that I had won two free tickets. I went back inside and the clerk asked if I wanted tickets or the $2.00 back. I decided to press my luck. Being sure that I would win again, I stayed inside to scratch these two tickets. Unfortunately, I cut my winnings in half and was only able to get one more ticket. This single ticket ended the fun. The five minutes of diversion was probably not worth $5.00, but it reminded me why I don’t buy lottery tickets. As a sidenote, this was a lower income neighborhood. Nothing against those who don’t make as much as others, but I have noticed that many in these neighborhoods are very uneducated when it comes to money. I wouldn’t be surprised if the people in front of me buy a few tickets every time they fill up or possibly every day. Those few dollars would add up to more than they can imagine over the months and years.
(Resume Investment Discussion)
So how much return on investment is enough when it comes to rental properties? Many people say not to worry so much about the cash flow as long as you are covering your expenses. They say that the many benefits of rental properties will outweigh the meager money entering your pocket on a month-to-month basis. As a reminder, the four benefits of rental are:
- Cash Flow
- Principal Reduction
- Tax Benefits/Depreciation
- Appreciation
I appreciate the four benefits, but in my properties, I’d like to concentrate on number 1 and let the rest be gravy, for a possible early retirement down the road. I’d rather be pleasantly surprised when I look at my finances in 10 years instead of looking and finding that I haven’t made as much as I hoped from appreciation. Ideally, I’d like to make back my out-of-pocket money within a few years and then start pulling a profit from then on. Obviously that is a huge return on investment and not the easiest thing to find, but I think it’s possible. Let’s look at an example. The following are using assumed numbers, so let me know if you think they’re inaccurate. I’m always willing to learn from the experience of others. Let’s buy a $100,000 property with 10% down and a 7% traditional 30-year mortgage (it could still happen, right?). Let’s assume that the rent is $1,200 a month. I think these numbers would be more attainable on a multi-family home than on a single family. Here is my breakdown:
Rent: $1,200
Loan: – $599
Taxes: – $87
Insurance: – $54
Repairs: – $72
Vacancies: – $96
Management: – $146
Potential Profit: $146 (per month)
Initial Investment: $10,000
Years for return: 5.7 ($10,000 / ($146*12))
As I had said previously, ideally, I would like to get paid back a little quicker than this, but still not bad. What is a good ROI for you?
Photo courtesy of midweekpost via Flickr.
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If you like, or can at least stand to read what I write,
make sure you add my RSS Feed to your list so you don't miss a single post.
If you have no idea what I'm talking about, read this.
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