The Ultimate Goal For An Investor
When you start paying attention to your financials, get involved with investments, or even start your own business, you’ll no doubt be inundated with an alphabet soup of acronyms to learn.
Things like P&L, LLC, or IPO…
But the most important one, hands down, is ROI, or Return On Investment.
Why is the return on investment so important?
It can be used across a multitude of applications: measuring the profitability of stock investment, evaluating the results of a real estate transaction, or as a tool to decide whether or not to invest in a business opportunity.
Luckily, ROI is a simple concept—which is why it’s a universal measure of profitability.
If you invest “X” number of dollars, how much money will “X” make, or return to you?
In other words, ROI reveals the return of an investment relative to the cost of that investment.
ROI is calculated by taking your annual investment income divided by cash invested. The amount of money earned is called cash flow. It is also referred to as the yield because it shows what the investment yields or produces.
A lot of people ask me, “Robert, what’s a good rate of return?”
This question is usually a sign of low financial intelligence, because a good rate of return depends on a few things. It depends upon the type of investment. It depends upon the economy. And it depends upon your financial intelligence.
For Kim and I, and most professional investors, infinite returns are the objective. For example, The Rich Dad Company was founded with $250,000 from investors. After three years, $500,000 was returned to investors. For the past 20 years, the returns to Kim and I have been infinite.
During the insanity of the real estate bubble, Kim and I made a lot of money investing for both cash flow and capital gains on one project.
The project was approximately 400 units in Scottsdale, Arizona – an affluent city close to Phoenix. At the time, the units were apartments being converted to condominiums. Kim and I took a deep breath, looked at the insanity of the market, and planned our exit strategy: selling 400 condos.
We invested with six other investors, $100,000 each, and raised a lot of cash via bank loans. We ended up converting the apartments to condos – with a lot of paint and landscaping – and sold the project out in a year. The real estate market was so hot that people were lining up to buy these well-priced units in a great location.
Kim and I got back our $100,000, and made a little over $1 million in a year. When the project was sold out, and with the assistance of a tax-planning expert, we placed that million into what is known as a 1031 exchange. This meant we paid zero taxes and invested the $1 million in capital gains, aka portfolio income, into a 144-unit apartment in Tucson, Arizona.
In Tucson, Arizona, the property we intended to buy also had a vacant lot adjacent to the property. This allowed us to expand the number of units to 252, which increased our monthly income.
Here are the numbers to that deal:
Project: 144 apartment units + 10 acres vacant land
Location: Tucson, Arizona
Tucson is a city with strong job growth from the University of Arizona, the military, and government agencies such as the U.S. Border Patrol. Since many jobs are transient, there is a high demand for rental housing.
Price: $7.6 million ($7.1 million for the 144 units and $500,000 for the vacant land)
Financing: $2.6 million in equity from investors $5 million via a new loan
Plan: Build 108 new units on the 10 acres.
Financing for addition: $5 million to build the 108 new units. The existing property and the 10 acres were used as collateral for the new $5 million construction loan.
Total units: 252 units when complete
Total package: $2.6 million equity + $10 million debt
New basis: $12.6 million
New appraisal: $18 million. An increase in rents increased the appraisal.
New financing: 75 percent leverage = $13.5 million ($18 million x 75 percent = $13.5 million)
Paid off old loans: $13.5 million – $10.0 million = $3.5 million
Return to investors: $3.5 million
Net transaction: Kim and I invested $1 million. From the $3.5 million return to investors, we received $1.4 million. $1.4 million is reinvested in a 350-unit property in Oklahoma.
Taxes on $1.4 million: 0
Today, Kim, and I still own the 252 units in Tucson. We receive monthly income from the property.
Since we have zero invested in the property, our ROI (return on investment) is infinite. Simply put, we receive money for nothing because we no longer have our own money in the property.
If I have zero in the asset and I receive $1, a return on zero is infinite. It is money for nothing. The asset is free, once we get our money back.
Keeping this overly simple, I’ll use the following for an example:
Let’s say a property costs $100,000 and my down payment is $20,000. To calculate ROI take your net income divided by the down payment.
If I receive $200 net monthly cash-flow income after all expenses (including the mortgage payment), I have a 1% monthly return on my investment of $20,000. That’s a 12 % annual return or $2,400 per year.
Our investment strategy is to get that $20,000 back and continue to receive $200 a month. Once the $20,000 is returned, the ROI is infinite.
To most people, $200 a month, a 1% monthly return, looks sickly. Certainly not exciting.
Yet if you own 100 of these small deals, that is $20,000 a month in cash flow. And 1,000 properties is $200,000 a month. That is more money than most doctors and lawyers make in a month.
On most of our investments, we have no money of our own in the property. If we do have money in the property, we are always in the process of getting that money back. In most cases, it takes a year to five years for our money to return.
An example of infinite returns in paper assets is if I buy 10 shares of a stock for $10, paying $1 per share.
The stock goes up to $5 a share, with the total value of ten shares increasing to $50. I then sell two shares for $5 and receive my entire initial $10 investment back. I now have eight shares of stock for free. Again, an infinite return.
Think about that the next time someone tells you an 8% return is a good return on your money.
Editor, Rich Dad Poor Dad Daily