*************Price Impact on ROI

One of the most commonly used valuation models for single family homes and short sales includes the Return on Investment or ROI. Despite the ease associated with using this calculation, the ROI is a robust measure of investment value that is both quick and convenient. However, it is also subject to a high level of volatility based upon the price of the property and type of funding in place. In fact, ROI is so dramatically influenced by funding mechanisms it is frequently considered a cornerstone by investment advisors. Let's take a look at a few hypothetical short sale situations to demonstrate the impact of price on the ROI as well as how it can be used to your advantage.Cash is still king and it speaks louder than ever especially with tightening lending standards and other banking irregularities; however, one area where cash doesn't hold up quite as well as the use of leverage is in the calculation of ROI or return on investment. Let's assume a short sale investor opts to purchase a property in cash for $100,000. If the property generated a one year rental return of $10,000 the total ROI is a fairly straightforward 10% or perhaps the property was flipped for a $20,000 profit and thereby the ROI was a handsome 20%. Both are completely realistic examples and certainly above and beyond what stocks, bonds or other inferior investments are currently able to deliver but the total return is a bit misleading. This can be due to the cost of borrowing the money in the first place (ie, what interest rate is being paid on the funds borrowed or the "spread" of the borrowed interest rate versus the total ROI received). For example, if the short sale buyer took out a home equity loan or borrowed against a 401-k plan, the interest rate may be a very reasonable 3 to 4 percent versus a total return of 10% - leading to a "spread" or ROI of 6-7 percent. On the other hand, some properties are truly purchased completely for cash so the entire ROI is theirs to keep...but is this always the best situation? Maybe-maybe not. There are a multitude of reasons to purchase a property for cash - not the least of which is the inability to obtain full financing on a distressed property, the ease and convenience of closing and the cost savings of not having to obtain PMI or other add-ons. However, there are very strong reasons to finance a property or use the maximum amount of leverage possible to maximize ROI. Going back to the former example, let's assume you financed a property for 80% of the value...$80,000 of the total price of $100,000. You used $20,000 out of pocket and received the same $10,000 annual rental or flipped for a quick $20,000. Instead of a respectable 10% to 20% return, you will now realize an eye-popping 50% to 100% return on your investment!Now let's take this one step farther...how important is price when it comes to ROI? The final answer is "it depends". Certainly buying right is a critical consideration in any short sale deal however, when using leverage, price becomes much less important due to the extreme rates of return generated. In the above examples, every $1,000 addition in cost reflects a significant gain or loss in the final cash ROI but in the leveraged position, paying an additional $1,000 for a property results in a paltry difference in the final ROI. Short sale investors should fully understand how to maximize ROI depending upon the price and funding source to be utilized for the deal. By doing so it is often feasible to pay more for a property while still maximizing the full profit potential of your portfolio.