Return on Equity Rundown

Many of the experienced investors we work with struggle with the hold/sell decision, so we created a simple calculator that quickly provides the financial information they need so that they can make a decision that will yield them the greatest financial results.

Instead of just focusing on balance sheet growth (due to loan balance reductions) and operating cash flow (how much goes into their pockets each month), calculating the Return on Equity (ROE) provides a more in-depth picture of how a property is performing.

This is largely due to the other two components of real estate investing…property appreciation and income tax savings.

We recently had a prime example of this when a client asked us to analyze their portfolio. “Sam” had purchased a single tenant office building 13 years earlier for $1,327,000, providing $265,400 as the down payment and leveraging $1,061,600. Annual cash flow for the initial year was $22,083, principal reduction was $34,314 and tax savings amounted to $20,156 – a 29% return on investment!

Many things happened over the next 12 years – capital expenditures, refinancing the loan, tax code changes, tenant transitions, etc. To simplify the numbers, let’s assume the property’s cash flow is now $26,500, principal reduction is $47,600 and tax cost $15,700 – a 22% return! Sure, it’s down 7 points, but 22% is still a great return, right?

Wrong! Why? Because the property is now worth $1,592,400 and the loan balance is $495,692, for a net equity of $1,096,708 – that’s how much you actually have tied up in the property. So, your 22% return is actually a 5% return on equity. Would you buy an asset that provided a 5% return? If not, you’re not maximizing the value of your equity!

In this case, Sam decided to utilize the benefits of a 1031 exchange by selling this asset for top dollar and reinvesting in two properties – a retail and an office property, which further diversified his portfolio.

Uncle Sam LOVES old money – he’s much better off when investors hold on to their investments, pay increasing income taxes and achieve lower returns. Your best defense? As soon as your return on equity is less than you’d achieve with another property, it’s time to move on. If you’d like to calculate your Return on Equity, just click the link below, submit your information and receive our FREE Return on Equity Worksheet!

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