Real Return

When you are comparing properties located within the same county/city you can use typical ROI formulas since state taxes/property taxes/insurance are likely the same. But what if you are looking at properties in multiple states?

This is where typical ROI formulas simply do not work because there are factors which render basic ROI calculations worse than invalid. For example, suppose you found the following identical (warning, over simplification coming) property in three locations: Austin, Indianapolis and Las Vegas.

  • Purchase price $150,000
  • Rent: $1,000/Mo.
  • Financing: 20% down, 4.5% interest, 30 year term.
  • Down Amount: $30,000
  • Debt Service (PI): $600/Mo

If you calculated ROI using the following formula:

ROI = (Return/ Cost) or

(12 x $1,000 - 12 x $600)/(20% x $150,000) or ($12,000 - $7,200)/$30,000 = 16%

So all three properties generate an estimated 16% ROI. Sounds great but it is invalid. Why? Below is a comparison between state income taxes and property taxes in three cities.

If instead I use the following (oversimplified) formula for estimating cash flow:

Cash Flow = (Rent x 12 - DebtService x 12 - PropertyTaxRate x PurchasePrice) x (1 - StateTaxRate)

For Austin: ($1,000 x 12 - $600 x 12 - 1.9% x $150,000)x (1 - 0%) = $1,950/Yr

For Indianapolis: ($1,000 x 12 - $600 x 12 - 1.07% x $150,000)x (1 - 3.4%) = $3,086/Yr

For Las Vegas: ($1,000 x 12 - $600 x 12 - 0.86% x $150,000)x (1 - 0%) = $3,510/Yr

This shows that while ROI is the same, what you will experience is very different. What does the same calculation yield for various "popular" investment cities?

So, buying the same property in Fort Worth generates $1,148/Yr cash flow while the same property in Las Vegas generates $3,510! Very different returns from the "same" property. But even the formula I used is not sufficient because it does not include costs such as association fees, insurance, assessments, etc. For example, typical home owners insurance in Florida is $1,933/Yr vs. $518/Yr. in Idaho. (I could not find data on comparative landlord policies but I expect it to be proportional.)

So, the only method I know to compare properties in different locations is to put together a cash flow model for each and compare the results. Some of the measurable factors that I know should be included:

  • Closing costs
  • State income tax
  • Insurance
  • Property tax

There are other factors to consider that are more subjective like the following:

  • Eviction time/cost: In Las vegas, typically less than 30 days and less than $500. In California, up to 1 year and thousands. In parts of New York State, up to 18 months and costs thousands of dollars.
  • Maintenance: In Las Vegas, homes have tile roofs, stucco siding, metal doors and window frames and desert landscaping (rock). In Atlanta, homes have composition roofs, masonite siding, wooden window frames and lush landscaping. The maintenance costs for a property in Las Vegas is usually much less than $1,000 per year. Based on properties I owned in Atlanta it is much more than $1,000/Yr.

Summary

When comparing properties across different areas (counties/states), ROI alone is not sufficient. You need to consider the actual cash flow that you can pocket taking into account the property tax, state income tax, etc.

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