Return On Equity


The question as to when to sell an investment property depends on many factors, including: the likelihood of future appreciation, the cash flow it produces, the ease or difficulty of managing the property, and the property's fit in an investor's overall investment portfolio.

A real estate investor should not overlook a simple measure to determine how hard their invested dollars are working: the property's “Return on Equity.” By analyzing return on equity, a real estate investor can compare a particular property with other potential investments in an effort to maximize the return on their investment equity.

Example: A small fourplex was purchased several years ago on very favorable terms. It produces a nice cash flow that resulted in an extraordinary 20% return the first year. Even with the following assumptions, which would produce a high return on equity, the return falls to less than 5% after 7 years.

  • 10% down payment
  • 90% Loan-to-Value (LTV), 7% fixed mortgage over 30 years
  • Appreciation at an average of 4% per year
  • Annual net income increasing by 2% per year

Year

Value

Debt (7%)

Equity

Equity as
% of Value

Annual
Net Income

Return
on Equity

1

$300,000

$270,000

$30,000

10.0%

$6,000

20.0%

2

312,000

267,020

44,980

14.4%

6,120

13.6%

3

324,480

264,062

60,418

18.6%

6,242

10.3%

4

337,459

260,890

76,569

22.6%

6,367

8.3%

5

350,957

257,489

93,468

26.6%

6,494

6.9%

6

364,995

253,842

111,153

30.4%

6,624

5.9%

7

379,595

249,931

129,664

34.1%

6,756

5.2%

8

394,779

245,737

149,042

37.7%

6,891

4.6%

9

410,570

241,241

169,329

41.2%

7,028

4.1%

10

426,993

236,419

190,574

44.6%

7,168

3.7%

11

444,073

231,249

212,824

47.9%

7,311

3.4%

12

461,836

225,705

236,131

51.1%

7,457

3.1%

13

480,309

219,760

260,549

54.2%

7,606

2.9%

14

499,522

213,385

289,137

57.2%

7,758

2.7%

15

519,502

206,550

312,952

60.2%

7,913

2.5%

16

540,282

192,220

348,062

64.4%

8,071

2.3%

17

561,894

191,361

370,533

65.9%

8,232

2.2%

18

584,370

182,934

401,436

68.6%

8,396

2.0%

19

607,744

173,897

433,847

71.3%

8,563

1.9%

20

632,054

164,207

467,847

74.0%

8,734

1.8%

As evidenced in the chart above, the investor in this example has a return on equity that starts diminishing significantly after about 7 years of ownership. In order to continue obtaining a much better return on invested equity, an investor should consider exchanging this one investment property after 5-7 years and acquiring multiple replacement investment properties. Later on, the investor will benefit again by exchanging these investment properties and exchanging into more (or larger) properties with leverage that will continue to produce a higher return on their equity.
Asset Preservation, Inc. (API) does not give tax or legal advice. The information contained herein should not be relied upon as a substitute for tax or legal advice obtained from a competent tax and/or legal advisor. If this message was sent to you in error or if you wish to be removed from our email list, please do one of the following: reply to this message, call us toll-free at 800-282-1031x342, email us at: e-newz@apiexchange-enewz.com or notify us in writing to: Asset Preservation, Inc., 4160 Douglas Blvd., Granite Bay, CA, 95746, Attn: Marketing Dept.