Asking the Right Questions About Investment Returns

Book: Real Estate by the Numbers | Authors: J Scott and Dave Meyer | Chapters: 14-15

← Real Estate Tax Basics for Investors | ROI, Equity Multiplier, Cap Rate, and Cash-on-Cash Return →

There are a lot of ways to measure how well an investment is doing. And honestly, that’s part of what makes investing confusing for a lot of people. You hear terms like ROI, IRR, cap rate, cash-on-cash, CAGR, and you’re not sure which one matters or when to use which.

Here’s the thing: the metric you pick depends on the question you’re trying to answer. Different metrics answer different questions. That’s the whole point of Chapter 14, and it’s a really useful framing before you get into the math.

What Question Are You Actually Asking?

The book walks you through a progression of questions, each one a bit more sophisticated than the last. Let’s go through them.

Question 1: How much money will I make from this investment?

This is the most basic question. Will I make $1,000 or $5,000? Obviously more money sounds better, right?

Not necessarily. If you need to put in $2,500 to make $5,000, but only $100 to make $1,000, the second investment is actually returning 10X while the first returns only 2X. Raw dollar amounts alone don’t tell you enough.

Question 2: What percentage of my initial investment will this return?

Better question. Now you’re thinking in terms of percentages, which lets you compare deals of different sizes. But there’s still something missing: time.

A 10X return sounds fantastic. But is it still fantastic if it takes twenty years?

Question 3: What percentage return per year?

Now you’re getting somewhere. A 2X return in one year is a lot more useful than a 10X return spread over twenty years. When you factor in the time value of money, speed matters a lot.

Question 4: What is the compounded return over time?

This is the most sophisticated version of the question. It accounts for the fact that money you get back early can be reinvested. The timing of each cash flow, not just the total, matters here.

These four questions map directly to the return metrics you’ll see used in real estate. The book summarizes it this way:

This is the Metric Matrix from the book. Keep it in mind as we go through the chapters that follow. When you see a metric, ask yourself: which question is it designed to answer?

Measurements of Profit (Chapter 15)

Before getting into the more sophisticated return metrics, the book covers the basic building blocks: NOI and cash flow.

“Profit” by itself is too vague a term for serious investing. It has no time reference. $50,000 in profit could be great or terrible depending on how long it took to earn, how much you had to invest, and what you paid in taxes along the way.

So the book breaks it down into more precise measurements.

Net Operating Income (NOI)

You’ve probably seen NOI mentioned before in this series. Here’s a quick refresher.

NOI is the income a property generates after subtracting operating expenses, but before debt service (mortgage payments), capital expenses, and taxes.

NOI = Gross Operating Income - Operating Expenses

Using the example from the book (Catherine Corp., a rental property), you’d take:

• Gross Potential Rent: $120,000
• Less Rent Loss (vacancies, etc.): -$12,000
• Plus Other Income: +$3,000
• Gross Operating Income: $111,000

Then subtract operating expenses like property taxes, insurance, management fees, repairs, etc. In the example those total $40,000, leaving:

• NOI: $71,000

NOI does not include debt service or big capital expenditures. That’s important because it lets you compare properties on a level playing field, regardless of how each investor has financed them.

One thing worth knowing: there’s some debate about where capital expenses (CapEx) go on a P&L. Some investors put CapEx above the NOI line (which lowers NOI and therefore lowers a property’s apparent value). Others put it below. Buyers tend to prefer CapEx above the line; sellers prefer it below. This matters when you’re comparing properties, so always check where CapEx shows up.

Cash Flow Before Taxes

Cash flow goes a step further than NOI. It accounts for everything that actually hits your bank account.

Cash Flow Before Taxes = NOI - Debt Service - Capital Expenses + Loan Additions

Using the same example:

• NOI: $71,000
• Less Debt Service (mortgage payments): -$40,200
• Less Capital Expenses: -$5,000
• Cash Flow Before Taxes: $25,800

“Loan additions” is a term the authors made up to capture cash inflows from things like a refinance or interest earned. It accounts for the full picture of cash moving in and out.

Cash Flow After Taxes

Take cash flow before taxes and subtract income taxes owed.

Cash Flow After Taxes = Cash Flow Before Taxes - Income Tax

In the example, with a 35% tax rate on the $25,800:

• Taxes owed: ~$9,100
• Cash Flow After Taxes: $16,900

This is as close as you’ll get to “real” bottom-line profit for a given year. It’s the actual dollars left over after paying everything, including Uncle Sam.

Why This Matters Before You Run the Numbers

Understanding which type of profit measurement you’re looking at is important. When someone shows you a deal and says “this property made $70,000 last year,” ask: is that NOI? Cash flow before taxes? After taxes? The number can look very different depending on which one they mean.

And that’s before you even get into rate-of-return metrics, which we cover in the next few posts.

The big takeaway from Chapters 14 and 15: slow down before you pick a metric. Know what question you’re trying to answer first. Then pick the tool that actually answers it.

← Real Estate Tax Basics for Investors | ROI, Equity Multiplier, Cap Rate, and Cash-on-Cash Return →