Calculating the ROI - question?

[JBagorio]

Given the following example:

Investor purchases house with $200,000 cash
House appreciates 5% in one year.
Investor sells house for $210,000 ($200,000 x 1.05).

Profit = $10,000 (sell price – purchase price = $210,000 - $200,000)
Return on Investment (ROI) = 5% (profit/initial cash investment = $10,000 / $200,000

My question is...With the example above (not the most ideal in terms of leveraging) the ROI is only 5%, but what if the cash to purchase the house at $200,000 came from a HELOC and in turn shortly there after converted to a conventional mortgage at a very good variable rate. Now that the entire amount is converted to a mortgage would this now mean that the financing was 100% from the bank? ... that the ROI now stands at 100%?

 

[Nir]

Hi, sounds like there is confusion between ROI per year while holding and TOTAL ROI calculated after selling. (total as you did not mention property holding period before selling)
There are different types of/ways to calculate ROI. Also, please distinguish between ROI/year from cash flow while holding and total ROI calculated after selling. see the difference? in your example there is a hidden assumption of zero cash flow while holding. ok that`s fine. Also, in theory when financing is 100% provided by the bank, ROI is infinite, not 100%! - another confusion this time in using the formula. why 100%? lastly, after selling whether 100% financed or not (assuming 0 interest due to short period of time holding, for simplicity) your profit remains the same $10K(!) as you paid back the LOC balance. so lot`s of confusion but it doesn`t have to be this way... it`s a simple case. good luck and hope my short explanation is clear enough. my advice for you is always understand the right formula for YOU to use, understand the logic. then plug in numbers into the formula and you will not conclude ROI is 100% for example {ROI = return on investment = (using the name literally) return (or profit)/initial investment amount x 100. Hope it makes more sense now. Regards.

 

[JBagorio]

QUOTE (investmart @ Jul 28 2009, 08:05 PM) Hi, sounds like there is confusion between ROI per year while holding and TOTAL ROI calculated after selling. (total as you did not mention property holding period before selling)
There are different types of/ways to calculate ROI. Also, please distinguish between ROI/year from cash flow while holding and total ROI calculated after selling. see the difference? in your example there is a hidden assumption of zero cash flow while holding. ok that`s fine. Also, in theory when financing is 100% provided by the bank, ROI is infinite, not 100%! - another confusion this time in using the formula. why 100%? lastly, after selling whether 100% financed or not (assuming 0 interest due to short period of time holding, for simplicity) your profit remains the same $10K(!) as you paid back the LOC balance. so lot`s of confusion but it doesn`t have to be this way... it`s a simple case. good luck and hope my short explanation is clear enough. my advice for you is always understand the right formula for YOU to use, understand the logic. then plug in numbers into the formula and you will not conclude ROI is 100% for example {ROI = return on investment = (using the name literally) return (or profit)/initial investment amount x 100. Hope it makes more sense now. Regards.

Sorry for the confusion. In the example it was a one year hold and no cah flow was accounted just to make it simple. I am just trying to figure out if the complete scenario would be considered as no money down from the investors point of view after the LOC was converted to a mortgage...and as you have said ...the ROI be infinite!??

 

[GaryMcGowan]

You need to remember that the banks will only lend to you 80% of the value, which is $168,000 for a conventional mortgage.

 

[Dan_Eisenhauer]

While it is true banks will loan 80% LVR, some, if not most, will allow HELOC to make up the difference.

If you use an HELOC to purchase a property, with none of "your own money" in it, your ROI would be infinite. However, you will be paying interest on that money... interest that is tax deductible.

Let`s assume, for the sake of argument, that you pay $8,000 in interest for that year, and that you are in a 40% tax bracket. Your effective investment in this property would be $4,800 (60% of $8,000).

Calculate your ROI on the $4,800 investment, and you will see you probably did very well.

 

[JBagorio]

QUOTE (GaryMcGowan @ Jul 29 2009, 08:01 AM) You need to remember that the banks will only lend to you 80% of the value, which is $168,000 for a conventional mortgage.

Hi Gary,

You are right about the percentage the bank will lend you. With what I am referring to in my example, I have already gotten the HELOC from a priviouse property of up to 80% LVR (Over 200K total). Then in the scenario I used 200K to to purchase the next property. With Scotiabank, their home equity lines are convertable to a mortgage anytime you want (the whole amount without any other requirements).

Sorry for the convoluted question...I hope I am explaining my situation right.

Jason

 

[JBagorio]

QUOTE (Dan_Eisenhauer @ Jul 29 2009, 11:23 AM) While it is true banks will loan 80% LVR, some, if not most, will allow HELOC to make up the difference.

If you use an HELOC to purchase a property, with none of "your own money" in it, your ROI would be infinite. However, you will be paying interest on that money... interest that is tax deductible.

Let`s assume, for the sake of argument, that you pay $8,000 in interest for that year, and that you are in a 40% tax bracket. Your effective investment in this property would be $4,800 (60% of $8,000).

Calculate your ROI on the $4,800 investment, and you will see you probably did very well.


Thanks Dan for your response. With what I have done "by converting the entire HELOC to a variable mortgage" with out any other requirement$ from the bank. Could I say that I got the financing from the bank 100% that makes my ROI infinite which is even better than 100% ROI, what I originally thought of?

 

[SeanKozicki]

QUOTE (JNB @ Jul 29 2009, 12:57 PM) Thanks Dan for your response. With what I have done "by converting the entire HELOC to a variable mortgage" with out any other requirement$ from the bank. Could I say that I got the financing from the bank 100% that makes my ROI infinite which is even better than 100% ROI, what I originally thought of?

In my humble opinion:

I think technically it is false to state that if the investor is using a LOC then the investment is the monthly interest expense.

From your perspective, the JV money you get for the investment, presumably the amount for the down payment, is as good as cash. It doesn`t matter where it came from; LOC, HELOC, cash, etc. In fact, you might not know where it came from.

If you are considering the interest expense as the investment then you are forgetting the opportunity cost the investor is forgoing in converting that LOC to real cash and investing it elsewhere. I also think that the LOC interest expense is not part of the investment (not in the denominator), but from the JV investor perspective, in the numerator (i.e. an expense subtracted from profit).

I think the technical ROI calculation for your investment is appx 5% = (210K-200K + cashflow) / 200K
The JV partner might calculate it is as (210K-200K + cashflow - interest expense) / 200K

You might look at:
cash-on-cash return = annual before-tax cash flow / total cash invested

I would like to hear Thomas Buyer weigh in....

 

[Dan_Eisenhauer]

As you can see, Jason. There are two ways to look at the ROI.

If you use a LOC, certainly the money you are using is secured by your assets somewhere. But, where does the money come from? Not out of your pocket. Therefore, IMHO, it is acceptable to work out you ROI based on the interest only payments.

Having said that, you also need to account for the repayment of that LOC at some point in time, whether through refinancing, or on the sale of the property.

And that comment just justified my belief that LOC interest is the only investment you have in the property. When you refinance, using existing equity in the property, your equity decreases, of course. But, we all look at our investment in the property as being the original investment LESS the amount we increased the mortgage by. If we are able to mortgage out, our ROI become infinite because we have none of our own money in the deal.

An LOC does exactly the same thing.

Jason, I do not understand what you are asking in your last question. ROI calculations are simply guides for us to evaluate a property. If you have your property 100% LVR, no matter what the source of the loans are, your ROI will be infinite, because you have none of your own money in the deal.

If you are JVing your deals, and the JV partner puts up 100% of the money, your ROI is also infinite, for the same reason. In this case your JV partner is your bank.

 

[JBagorio]

Sorry for my confusion. Initially I did not know how I will word this question, but please allow me to reconstruct and hopefully clarify.

Basically I am trying to figure out how well I have done in the given situation: I have purchased property B using 100% HELOC I got from property A (all paid off) and converted the entire amount to a variable mortgage after 6 months. Scotiabank have this deal where you could convert the heloc to a mortgage when ever you want. Of course I have taken HELOC out again against property B there after, but that`s another story.

Anyhow my question is, how can I calculate my ROI given the scenario?

So if I get it right I have factor in into the calculation part of the LOC interest payments durring the 6 months period?

 

[Dan_Eisenhauer]

I do not mean to sound crass, but how do you want to calculate your ROI? As I understand it, you have NONE of your own money in the deal. Why are you worrying about your ROI? It is infinite.

What you need to do is concentrate on optimizing your property management to ensure your cash flow stays positive, while controlling your expenses.

If your question has more to do with measuring your income against others, then you need to find out what other similar properties in the neighbourhood are renting for, as well as trying to find a way to compare your expenses to theirs. Joining a Landlord`s Association would be one way to do that.

 

[JBagorio]

QUOTE (Dan_Eisenhauer @ Jul 30 2009, 10:07 AM) ... you have NONE of your own money in the deal. Why are you worrying about your ROI? It is infinite.

Thanks Dan, This all I wanted to hear and nothing more. Just wanted to put it in the right context...