Return on Equity. Its More than Cash Flow

Cash flow is important but there is more to real estate investment than the bottom line. Return on equity (ROE) is a percentage measurement of the return received on a real estate investment property, i.e., the full value of the investment once you include deductions and debt reduction to the income earned.


It usually based on the first year's ownership dividing the cash invested by the cash return from rents, etc. It can also be calculated in subsequent years, based on the projected value of the property, less the mortgage balance. You would use the current equity investment you have in the property adjusted by any increase in value and reduction to your mortgage balance.

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An Insight into the Future

Unlike other Return on Investment (ROI) calculations; ROE measures your actual return on a changing number. It allows you to determine where best to allocate your resources.

The initial investment (usually the down payment) has not changed, but over the years, other factors do, which changes your ROE. That is because of the value of your equity changes.

Let us review the benefits investments in real estate provides.

 

Regardless of the reason behind the purchase we can still provide either cash analysis or return on equity reports to cut through the emotion. Hard data can sometimes prevent the heart ruling the head.

1

Reduced your balance

As you make payments payments, you're reducing the principal loan balance and your equity increases because you owe less.

2

Appreciation

Property increases in value over time. Therefore, while you reduce the mortgage balance you are also benefiting from an increase in value.

3

Cash Flow

Barring a really bad renter, you will be banking some cash. Hopefully, this is over and above the mortgage payment and expenses.

4

Income tax savings

Depreciation is perhaps the most misunderstood and underappreciated benefit in the real estate investment model. Each year you can deduct against the rental income a portion of the value of the property as depreciation. You did not spend anything, but the deduction assumes you had.

Static Analysis or Dynamic

You buy a rental home for $200,000 with $40,000 (20%) down. The year of the purchase, you see that it is worth $200,000, but you only owe $160,000, as you have that $40,000 down payment as equity.

Let us assume that your annual positive cash flow is $7,200, or $600 per month over mortgage and expenses. So, our ROE is $7,200 / $40,000, or 0.18 = 18% Return on Equity.

Fast forward 10 years. You have been paying down your mortgage, and the home has appreciated in value, now worth $236,000. Your balance due on the mortgage has dropped from $160,000 to $132,000. You are also getting a little more in rent (3% year over year increase) so your cash flow is now $9400 per year. Now, look at your equity. $236,000 - $132,000 = $104,000.

A simple or static investment analysis will show an improved rate of return in comparison to the original 18%.

Equity-01

Cash flow (after all expenses and deductions) $9400/Original Investment (down payment) $40,000

= 23.5%

Now let's do the calculation again using a dynamic analysis approach.

Cash flow (after all expenses and deductions) $9400/Current equity in the property $104,000

= 9%

What happened? When we own a property, we begin to accumulate equity in addition to our initial investment. In essence the deposit and any equity accumulated (appreciation + debt reduction) is ‘trapped equity’.

In order to make sound financial decisions we need to understand the rate-of-return on this ‘trapped equity’. If the returns on equity are acceptable, you know that keeping the property is the right move. If the returns are not acceptable, this suggests the investment needs our attention, e.g., raise rents or reduce expenses. If neither of these could be achieved the investor may want to consider the following actions.

Hold the property but refinance

This approach would essentially allow you to cash out on your initial $40,000. You would have no actual money left in this deal, and you could use the funds to purchase another property or find an alternative investment.

This method is how many successful investors accumulate wealth through real estate.

Refinance
Sale

Sell the property

If the property is not meeting your investment goals, you should consider selling the and reinvesting the proceeds in a better performing property or non-property investment.

If you do go down the sales route, you will want to figure in the cost of sale. Typically, we see pretax costs (realtor and closing costs) amounting to about 8% of the sale amount.

Any gains that you have made will be subject to capital gains taxes. Capital gains taxes can be offset by reinvesting the proceeds using a 1031 Exchange. 

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What People Are Saying About Us

review rating 5  
I have been using Gulf Coast to rent my property for about 2 years and they have done an amazing job. They are easy to deal with, responsive, professional and organized.I have had the pleasure to work with Maria, Scott and Jamie and highly recommend them.

photo (1) Kirenia Sintas
2/16/2021

review rating 5  
We are a General Contracting business, we have been working with Matt and Scott on multiple projects. We find them to be Responsive, Honest and Upfront.They care about there residents, they are Absolutely Great to deal with. I would recommend them in a Heartbeat!!Great Management, Awesome a Attitude and more importantly, ( THEY CARE) These Guy's are Rare!!

photo4 Scott Schrader
2/15/2021

review rating 5  
Gulf Coast manages five properties for me. They have been wonderful. They take care of issues, communicate regularly, consult me when they need to and just handle smaller matters, and they provide excellent records for tax purposes, etc. I couldn't be more satisfied with their services. I'd like to give a special call-out to Maria Palatino, who deals with all things financial and special handles a slightly complex monthly interaction with the trust company that "holds" several of my rentals. Maria is responsive and helpful!

Photo2 Meryl Ginsberg
1/26/2021

review rating 5  
I started working with this company about 2 1/2 months ago for a move across country. Laurie Rastovski was my leasing agent. She really made everything very simple for me, the whole process was stress free 100% with the application. She was great to work with. I moved into the property a few days ago and I am very pleased! This place is perfect for me and it was clean and move in ready! I like this company and would recommend!Thank you for taking care of us :)

Photo3 Psychic Echosunrise
11/16/2020

review rating 5  
I have been using Gulfcoast since 2017. They have been invaluable in renting our Sarasota property. The staff including Andy, Scott and Maria the bookkeeper are all incredibly responsive and courteous.

Vince Vince Lepera
1/22/2021

Want to Learn More?

If you’d like to learn more about our properties and what it’s like to work with Gulf Coast Property Management, get in touch. We’d be happy to talk more about our rental properties, our application requirements, and our leasing process.