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Let’s Talk ROI

Return on Investment or ROI, what a great subject for the beginning of the year. So what is ROI? Well, simply put, if you invest $100 and make $100 on that investment, you had an ROI of 100% and now have $200 in your investment.
If you invested $1,000 and made $100, you would have an ROI of 10% and if you invested $10,000 and made $100, you would only have an ROI of 1%. 1% would likely be the least attractive to people in this scenario, but we’re missing one more key element, the time frame.
If your ROI was 100% over the year, that would be great, but if you were making that 1% ROI on your $10,000 investment every day, over a year you would have made $36,500 or 365% ROI per year. Without knowing the time frame, ROI can change drastically.
Now, let’s apply this to Real Estate, or more precisely rental Real Estate where your ROI gets magnified by leverage. Let’s start with a nice suited bungalow for $300,000. With a 25% down payment, you need $75,000 for a down payment. Let’s say its pretty beat up, so after legal fees and repairs your entire investment is $100,000.
After holding onto the property for a year, it’s gone up in value 2.5%, so now it’s worth $307,500. Your investment has increased $7,500 or 7.5% per year, great news, but it gets better. Also during the year, you have paid some of your mortgage down during the year, simply by making your regular payments.
Due to the current low interest rates, after the first year, the mortgage is paid down $6,000. Suddenly your investment made $13,500 or 13.5% in yearly returns. Yet there is more. You see there is a little bit of cash created by renting out the main floor and the suite. After taxes, insurance, mortgage payments and even setting aside a reserve fund, you still make $300 a month cash flow. That is another $3,600 per year or a grand total of $17,100 which works out to 17.1% ROI per year.
That is the positive side of ROI with Real Estate. Of course, this looks at a healthy market that is growing, very similar to the current environment we have, if however, the market is relatively flat, it’s still not that bad. Taking out the 2.5% increase in the property value, that still leaves you with a 9.6% return.
With the current volatility of almost all the markets these days, 9.6% per year suddenly comes out looking pretty rosy as far as a safe return on your investment. When you also consider there is a very optimistic upside to the market right now with low vacancy rates, increasing in-migration to our province and lots of jobs, it gets even rosier.
What I didn’t talk about however, is the back end. This is when you actually sell the property and is what eats up a huge percentage of perceived returns. When you factor in sales commissions, mortgage payouts and legal fees at the time of sale, you can easily see $15,000-20,000 of potential returns wiped out quickly.
This is why any venture into the rental market should consist of a long term outlook. If you aren’t willing to commit at least five years and possibly longer depending on the markets, you might end up giving all your profits back at closing time.

About the author

Bill Biko

Bill Biko

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