Thankfully, the income property investor needs to spend a little more time understanding Return On Investment (ROI) than the average stock market Kool-Aid drinker. With stocks, you buy it and hope it goes up in value (or down if you’re shorting). The key idea is the anticipation of simple appreciation.
In real estate, we get excited about appreciation too, but there is more to it. So much more because we’ve got amplified leverage. Here’s how it works. To purchase a $100,000 property these days you’ll likely be required to put up 20% of the purchase price, which is $20,000. Right off, you can see the advantage over stocks. You control a $100,000 asset using only a fraction of that amount of money.
Here’s where the idea of amplified leverage kicks in. Assume your income property appreciates in value a solid six percent during the first year you own it and is now worth $106,000. You don’t calculate your ROI on the $100,000, because you didn’t pay that much, You only paid $20,000. That means you made $6,000 on a $20,000 investment. That’s a 30% return! And that’s right in the ballpark of what we consider an average year around here.
When investing in real estate, you’re using the banker to put up most of the money and take most of the risk, while you realize most of the profit. But there’s even more to the equation than that. Stay tuned next time when we discuss more pillars of real estate ROI.
