Are Your Real Estate Flips Flops?

The FBI arrested two NFL replacement referees today. They were charged with felony embezzlement for stealing the Monday night game from the Green Bay Packers. These two officials conspired to make one of the worst calls in the history of the NFL, granting a game ending touchdown catch to the Seattle Seahawks, who were charged by the FBI with receiving stolen property.

The next time I attend a Redskins game, I am tempted to get liquored up, get close to the field before the game, and shout at one of the replacements, “You should be mowing my grass, moron.” But I won't. Yes, I will get liquored up, but I won't berate the replacement officials, even assuming that I could put together a coherent sentence in that condition.

The replacement officials come from small college football. The NFL is to small college football what the space shuttle is to a single engine prop plane. These guys have never experienced the speed and violent contact of an NFL game. If they had a season to adjust, they might become competent. Nonetheless the integrity of the game, and mostly importantly RGIII's health, depend on quality officiating. Gimme back the damn regular refs. Of course, I'll complain about them when they're back.

Are you tempted to enter the wonderful world of real estate investing? If you are, this post is critically important to your success. I am going to show you how to calculate return on investment. If you decide you aren't interested in this topic, real estate investing isn't for you. If you want extra income, get a job at Burger King. At least you won't lose money flipping burgers instead of real estate.

Return on investment (ROI)is a simple concept to explain, but a sometimes difficult concept to apply in the real world. ROI is calculated by dividing your investment return by your investment, which yields a percentage. Let's take on a very simple example.

Let's assume you bought a house on January 1^st for $100K. Let's also assume you paid cash for it. Now let's assume you sold it on June 30^th for $125K after selling expenses. You have a profit of $25K. If you take the $25K profit and divide it by your original $100K investment, you have a 25% return on investment. That's true but it doesn't give you any useful information versus other investments you could have made, whose investment returns are usually expressed on an annual basis.

To make our ROI an annual return, since you held the house for half a year, simply double the 25%. Thus, your annual ROI was 50%. In fact, if we were being exact and using compound interest, your return would be a little greater than 50%. However, our approach is accurate enough for what we intend to do. Hopefully, this simple math isn't beyond you. If it is, find a fifth grader to explain it.

Let's now make our example a little more complex. Let's add the assumption that you didn't pay cash for the property. Let's assume you borrowed $50K from a bank. Now let's calculate your ROI. You sold the house for $125K after expenses, but you paid the bank $5K in interest. So your profit is $20K instead of $25K. Now your ROI is $20K divided by your investment of $50K or 40%. If we double that to annualize it, we get an annual return of 80%. Why are we using $50K as your investment? Because that is how much you invested of your money. Notice that borrowing increased your annual ROI from 50% to 80%. That is the magic of debt. It is called leverage. It also functions on the down side, however.

Let's change our example to assume that we sold the house for $75K after expenses instead of $125K. Without a loan, our ROI is ($25K) divided by $100K or a 25% loss, which annualizes to a 50% loss. If we assume that we borrowed the $50K, our ROI becomes ($25K) divided by our $50K investment or a 50% loss, which annualizes to a 100% loss, before considering the interest you paid to the bank. In other words if you did this deal twice in a year, you would lose your entire $50K investment.

We can conclude that debt not only magnifies your ROI when you make a profit, it magnifies the effect of your loss on the down side. Thus, debt increases your investment risk. Hopefully, this is relatively simple math. In my next post, I will explain when making money investing in real estate is possible – and when it isn't. An understanding of ROI is necessary for the analysis.

My marketing person for my eventual book has advised me to ramp up my activity on Twitter. If you are on Twitter, my handle is @fstitely. I tweet mainly about business and the Redskins as you might expect.

Today, I received a direct message from one of my followers. She, I hope she is a she, wrote to me that she has a vagina. Of course, this is really special information that sets her apart in my eyes since only approximately 50% of the world has that particular body part. I wonder what makes her specific female crotch organ special. I am guessing hers is set apart by the amount of drugs I would have to take if I got close to hers. Yes, Twitter has porn spam.

Thanks for reading. As always, send me your comments, gripes, and suggestions for posts. I take requests – at least ones that don't involve vagina’s. For real tax and accounting advice, please visit our main S&K web site at www.skcpas.com. Until next time, let's do it to them, before they do it to us.