The Elusive "Rate of Return" Issue Strikes Again

Here is another question I was asked today.

What is a typical or expected rate of return on a real estate investment?

“A "rate of return" is a broad stroke for a term that can have several meanings. Expected returns vary by property type, investor demand, region of the country, risk, availability of financing, etc.

I think it is important to make sure your definition of "return" is clear. Typically real estate investments are offered on a cap rate which is expressed as a ratio of net operating income to sales price excluding the impact of debt. In many cases this is not the complete picture of "return on investment" or ROI. There are many other influencing factors such as depreciation, duration of hold, cash-on-cash return, internal rate of return, capital accumulation during hold, etc.

Since we don't have the benefit of analyzing your prospective investment here is a rule of thumb - more risk should demand higher return and vice versa.

One more point. Once you understand "return on investment" make sure the investment is being offered as such. For instance, some investments are advertised with X cap rate. When you dig in you find out it is based upon "scheduled income" or they used an inadequate vacancy factor or no vacancy factor at all! This is key to your successful valuation and evaluation of the offering.”