How Does Property Investing Work and Why is ROI NOT The Best Measure of Profit in Real Estate Investing?

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So how does property investing work and how do I make a profit?

There are 3 main points when talking “profit”:

  1. The same property can have a number of different financial results

2. Profit is not the same as cash

3. Percentages can be skewed, so it is important to look at the dollar outcome and the percentage return to see the whole picture

The questions to ask yourself before entering a real estate deal, whether it’s a simple renovation or a multi-dwelling development, are: 

1. How do I know if a property I am thinking about buying is a good one? 

2. How much is a ‘good return’ for the money, time, risk and effort I put into this project?

3. How do I know whether my asset is performing well?

It is common in the real estate industry to use ROI or Return on Investment to measure the profitability of a project.

ROI measures a $ of profit returned per $100 of asset. The limitations of ROI is that we are looking at profit. And as I have already described earlier in the previous blog, How you can go broke making a profit on paper, profit is open to manipulation. 

Secondly, specific to real estate, we are using total asset price in the formulae to calculate the return. In real estate investing, unless you have deep pockets, you are borrowing money to finance the deal.

With ROI, we are not really considering any kind of leverage, which is very relevant to our investment decision. 

Yes, we have built in the interest we are paying back for the loan into the profit, but that said we are not taking into account the actual amount of our own cash we are putting into the deal. 

Instead with ROI, we are spreading the profit over the total amount of the asset including the amount we borrowed. 

Alright! Now that we have discussed the limitations of the most popular measure of profit in real estate investing (and how you can go broke making a paper profit) , let’s move on to how Jason and I measure the profitability of our investments.

We prefer to use CoCR (Cash on Cash Return) instead of ROI. 

CoCR measures a $ of profit returned per $100 of cash invested. 

Why do we love CoCR? 

Simple! Because cash in the bank is ultimately the clearest and best way to understand how successful your projects are. 

Unlike profit, cash is harder to manipulate. It is easy to measure accurately and you don’t need to be an accountant to measure how much cash you get back for ever $100 you put in on a project by project basis. 

So that is a snippet to the question you asked ” how does property investing work”.

Also, and most importantly, nobody I’ve heard of went broke taking cash profits!

If you would like to understand if your investments are making the best return possible with all the options and strategies available to property investors, or to understand how does property investing work, book a chat with me using the link below.

Shehan

Shehan Tambinayagam

Click here to book a chat with me

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