Return on Equity - Analysis and Strategy

Bill F.

Investor · Boston, MA · Member since 2015 · 1k+ posts · 3k+ votes

9y

@Andrey Y. What would you do with the money? Do you have a deal lined up or are you looking to optimize?

I think the low ROE numbers show you did somethings right; you bought in an area with good appreciation and you've paid down the debt. Why stop the train now?

Lots of people talk about The 2% Rule for buying, but the 2% Rule also is an ROE calculations. If you go by these rules of thumb you are double what a 'good' property is.

If I was in your shoes ( and man do I wish I was) I would consider getting a LOC against all three. That gives you an option to deploy your equity quickly if you find a great deal, but doesn't leave you with a pile of cash and no where to put it.

As the old saying goes "the time to look for financing is when you don't need it"

OP

Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes

9y

Originally posted by @Steve Vaughan:

I suppose it depends on what you are trying to do overall @Andrey Y.Are you trying to expand rapidly?

I have high equity in my commercial assets. They are in LLCs and I'm more comfortable from a risk management standpoint. Residential houses in my own name I like more leverage, provided the rate is fixed and below 5%. The lender doesn't even bother you for your financials and stuff like they do with commercial loans. No rate risk or call risk either.

Are these houses? IRR is a more important metric to me. My guess is these appreciate well. @Jay Hinrichs will tell you- the money is in the appreciation. I've learned that as well.

If your options are to sell and exchange to a midwest neighborhood you don't understand or something, I'd sit and hold in my backyard, pending where you feel you are at in your market cycle. I'm not against selling if you think you are peaking. I'm against taking a good thing and messing it up with an unknown.

I'd do a cost-benefit analysis on potential refi's. Cost and hassle to tap the equity vs amount you get and new rate/term. Good luck to ya!

Thank you Steve.

These are condos. Minimal repairs and not a lot of headaches.

I was told that below 6.5 or 7% ROE is "bad" and that the equity should be working better for me in terms of cash flow. I was thinking if I sell to 1031 exchange into a small multifamily in a cheaper market. Although, I am at at loss as to which markets I should be targetting.

OP

Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes

9y

Originally posted by @Jay Hinrichs:

keep them... is my vote... 6% with all the hard work done.. in a place that is awesome for apprecation like Honolulu.. thats what I would do personally.

Gotcha, Jay. I think over time the ROE will slowly trickle down. I think I can raise the rents if I upgrade the 2nd and 3rd condos. Maybe that is an option as well.

OP

Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes

9y

Originally posted by @Bill F.:

@Andrey Y. What would you do with the money? Do you have a deal lined up or are you looking to optimize?

I think the low ROE numbers show you did somethings right; you bought in an area with good appreciation and you've paid down the debt. Why stop the train now?

Lots of people talk about The 2% Rule for buying, but the 2% Rule also is an ROE calculations. If you go by these rules of thumb you are double what a 'good' property is.

If I was in your shoes ( and man do I wish I was) I would consider getting a LOC against all three. That gives you an option to deploy your equity quickly if you find a great deal, but doesn't leave you with a pile of cash and no where to put it.

As the old saying goes "the time to look for financing is when you don't need it"

Nope.. no deal lined up yet. Also, I don't need the money.

I was thinking along on the line of having too much equity is too much exposure or skin in the properties.

I know that even full time experts are having trouble finding great MF deals with cap rated crunched the way there are.. what chance do I have? I have been looking in Anchorage, AK. Deals with solid cap rates of 8 are not hard to come by, but I have been hesitating to invest in a place where there is a mild population loss and some economic decline.

Bill F.

Investor · Boston, MA · Member since 2015 · 1k+ posts · 3k+ votes

9y

@Andrey Y. I think these are one of those 'good problems'.

From a liability point a view a LOC can equity strip the properties the same way a conventional mortgage would. From someone searching the Registrar of Deeds the see a lien against the property which gives you some protection against ambulance chasers.

I've heard the same about MF and even that some of the"smart" money is getting out of everything MF that is non core.

Anyway, good luck and hope you find a solution.

Matt R.

Sherman Oaks, CA · Member since 2013 · 3k+ posts · 2k+ votes

9y

Originally posted by @Andrey Y.:

I wasn't sure the appropriate subforum for this topic, since a few seem relevant.

I decided to calculate ROE on 3 properties I own in Oahu, Hawaii. I used exact mortgage balance and used in-building comps to calculate market value (all 3 are condos). I included all expenses, maintenance fees, and a healthy repairs reserve (which I have never came close to using in 4 years) to calculate net cash flow.

Numbers are below:

Property #1: Equity = $202,815 Net Cash Flow = $10,270 ROE = ~5.1% {~56% LTV}

Property #2: Equity = $103,284 Net Cash Flow = $6,109 ROE = ~5.9% {~57% LTV}

Property #3: Equity = $90,588 Net Cash Flow = $2,475 ROE = ~2.7% {~61% LTV}

What do you guys think of these ROE numbers? To me they seem quite low (especially the 3rd property). Do you recommend selling, maybe 1031 into an apartment building somewhere else? 1031 into several SFH rentals, geographically diversified? Stay put?

I am open to selling the second and third properties. The first, probably I will never sell because its in a desirable area on the beach. Would you refinance any of them?

I listed the LTVs above. I actually realized, I am under-leveraged for my level of risk (I think?). Thank you for reading.

ROE Formula

Annual Cash Flow + Net Increase or Decrease in Property’s Equity

Divided by

Accumulated Equity Prior to Year

I think this ROE formula gives one a more accurate accounting picture and includes after tax profits at a years end as if you were going to sell. Most probably would not mess with selling after they calculate the appreciation accordingly.

Good luck!

2 Reply

OP

Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes

9y

@Matt R.

Annual cash flow, Net increase/decrease in property's equity - these I understand. Accumulated equity prior to year I am having trouble to grasp. Say I am using the year 2016, lets say there was $10,000 annual cash flow, and the equity increase that year was $20,000 .. how would I go about getting the "accumulated equity prior to year"? Cheers.

Matt R.

Sherman Oaks, CA · Member since 2013 · 3k+ posts · 2k+ votes

9y

That would be the total equity amount (invested plus gained) at the end of last year if I understand your question correctly.

http://www.rentalsoftware.com/return-on-equity-real-estate/

Mike Dymski

Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes

9y

Hey Andrey. Nice work on considering your ROE. I'd recommend including both principal reduction and predictable future appreciation in your return calculations (along with the cash flows). Profit comes in three forms and you will want to include all of them in your calculations to benchmark investment alternatives. In some cases, you may want to level the playing field on LTVs too when comparing investment alternatives at different leverage amounts.

3 Reply

OP

Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes

9y

Originally posted by @Matt R.:

That would be the total equity amount (invested plus gained) at the end of last year if I understand your question correctly.

http://www.rentalsoftware.com/return-on-equity-real-estate/

Thanks Matt! That link is a good resource, I'll have to reread it a few times to grasp it totally. The naturally thing that comes to mind is, how does this ROE calculation relate to ROI/IRR (both in practical and mathematical senses) and should one metric be considered more strongly over another in certain situations.

OP

Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes

9y

Originally posted by @Mike Dymski:

Hey Andrey. Nice work on considering your ROE. I'd recommend including both principal reduction and predictable future appreciation in your return calculations (along with the cash flows). Profit comes in three forms and you will want to include all of them in your calculations to benchmark investment alternatives. In some cases, you may want to level the playing field on LTVs too when comparing investment alternatives at different leverage amounts.

If you take a look at the link @Matt R. posted above, they seem to state that that ROE calculation takes principal reduction into account, so you would have to add it when calculating net cash flow. Correct me if I am wrong.

Mike Dymski

Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes

9y

Originally posted by @Andrey Y.:

Originally posted by @Mike Dymski:

Hey Andrey. Nice work on considering your ROE. I'd recommend including both principal reduction and predictable future appreciation in your return calculations (along with the cash flows). Profit comes in three forms and you will want to include all of them in your calculations to benchmark investment alternatives. In some cases, you may want to level the playing field on LTVs too when comparing investment alternatives at different leverage amounts.

If you take a look at the link @Matt R. posted above, they seem to state that that ROE calculation takes principal reduction into account, so you would have to add it when calculating net cash flow. Correct me if I am wrong.

You got it...cash flow + principal reduction + appreciation.

David Faulkner

Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes

9y

It always seemed strange to me to consider only ROE on an appreciating asset, where most of that equity was not capital you put in (I doubt you put 40%+ down at purchase), but was equity "created" by market appreciation, and it would not exist at all if there was no appreciation and then ironically the ROE would look much better in that case, but not in reality with total return ... not saying ROE is a bad metric, only that like with all metrics it should be considered in context of a complete analysis ... each metric tells you something but also has its limitations. Understanding what each metric can and cannot tell you, and combining them in such a way that you get a complete picture is the key ... this takes experience and frankly can be as much art as it is science.

5 Reply

OP

Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes

9y

Originally posted by @David Faulkner:

It always seemed strange to me to consider only ROE on an appreciating asset, where most of that equity was not capital you put in (I doubt you put 40%+ down at purchase), but was equity "created" by market appreciation, and it would not exist at all if there was no appreciation and then ironically the ROE would look much better in that case, but not in reality with total return ... not saying ROE is a bad metric, only that like with all metrics it should be considered in context of a complete analysis ... each metric tells you something but also has its limitations. Understanding what each metric can and cannot tell you, and combining them in such a way that you get a complete picture is the key ... this takes experience and frankly can be as much art as it is science.

You're definitely on point. I wanted to try and calculate IRR.. but I think that is above my paygrade. I started with ROE since someone told me less than about 7% is not favorable and one should consider repositioning if it is much lower than that.

Matt R.

Sherman Oaks, CA · Member since 2013 · 3k+ posts · 2k+ votes

9y

Like David said and here is the Oahu median/average since 1985. The condos hold up nicely compared to Sfrs. 369% to condos 361%. I think Honolulu would be at least 100%+ higher than island wide.

Median & Average Sales Prices

Single Family

Year	Median Sale Price	Percent Change	Average Sale Price	Percent Change
1985	$158,600	N/A	$205,400	N/AN/A
1986	$171,200	7.90%	$211,100	2.80%
1987	$190,200	11.10%	$281,963	33.60%
1988	$210,000	10.40%	$312,300	10.80%
1989	$270,000	28.60%	$372,361	19.20%
1990	$352,000	30.40%	$498,511	33.90%
1991	$340,000	-3.40%	$432,338	-13.30%
1992	$349,000	2.60%	$411,868	-4.70%
1993	$358,500	2.70%	$436,898	6.10%
1994	$360,000	0.40%	$423,371	-3.10%
1995	$349,000	-3.10%	$429,613	1.50%
1996	$335,000	-4.00%	$409,441	-4.70%
1997	$307,000	-8.40%	$380,507	-7.10%
1998	$297,000	-3.30%	$370,021	-2.80%
1999	$290,000	-2.40%	$377,497	2.00%
2000	$295,000	1.70%	$406,331	7.60%
2001	$299,900	1.70%	$375,857	-7.50%
2002	$335,000	11.70%	$418,231	11.30%
2003	$380,000	13.40%	$479,377	14.60%
2004	$460,000	21.10%	$591,354	23.40%
2005	$590,000	28.30%	$744,174	25.80%
2006	$630,000	6.80%	$778,393	4.60%
2007	$643,500	2.10%	$794,183	2.00%
2008	$624,000	-3.00%	$792,520	-0.20%
2009	$575,000	-7.90%	$684,341	-13.70%
2010	$592,750	3.10%	$712,251	4.10%
2011	$575,000	-3.00%	$707,402	-0.7%
2012	$620,000	7.8%	$754,142	6.6%
2013	$650,000	4.8%	$804,933	6.7%
2014	$675,000	3.8%	$856,826	6.4%
2015	$700,000	3.7%	$875,373	2.2%
2016	$735,000	5.0%	$891,332	1.8%

Condo

Year	Median Sale Price	Percent Change	Average Sale Price	Percent Change
1985	$89,800	N/A	$105,900	N/A
1986	$94,000	4.70%	$108,100	2.10%
1987	$104,500	11.20%	$126,394	16.90%
1988	$114,000	9.10%	$140,377	11.10%
1989	$135,500	18.90%	$164,496	17.20%
1990	$187,000	38.00%	$225,901	37.30%
1991	$192,000	2.70%	$219,318	-2.90%
1992	$193,000	0.50%	$211,649	-3.50%
1993	$193,000	0.00%	$210,573	-0.50%
1994	$190,000	-1.60%	$210,762	0.10%
1995	$182,000	-4.20%	$206,134	-2.20%
1996	$175,000	-3.80%	$202,494	-1.80%
1997	$150,000	-14.30%	$178,090	-12.10%
1998	$135,000	-10.00%	$160,978	-9.60%
1999	$125,000	-7.40%	$157,418	-2.20%
2000	$125,000	0.00%	$165,674	5.20%
2001	$133,000	6.40%	$168,013	1.40%
2002	$152,000	14.30%	$181,933	8.30%
2003	$175,000	15.10%	$205,165	12.80%
2004	$208,500	19.10%	$251,328	22.50%
2005	$269,000	29.00%	$320,003	27.30%
2006	$310,000	15.20%	$363,639	13.60%
2007	$325,000	4.80%	$381,263	4.80%
2008	$325,000	0.00%	$383,418	0.60%
2009	$302,000	-7.10%	$346,103	-9.70%
2010	$305,000	1.00%	$359,151	3.80%
2011	$300,000	-1.6%	$357,881	-0.4%
2012	$317,500	5.8%	$374,343	4.6%
2013	$332,000	4.6%	$393,396	5.1%
2014	$350,000	5.4%	$418,186	6.3%
2015	$360,000	2.9%	$415,533	-0.6%
2016	$390,000	8.3%	$447,512	7.7%

Alexander Monnin

OH · Member since 2017 · 45 posts · 38 votes

9y

@Andrey Y. The book "What Every Real Estate Investor Needs to Know About Cash Flow" is great for learning IRR. I read it in 2-3 days and created my own spreadsheet for calculating IRR by the end of the week. Definitely worth the $10.

OP

Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes

9y

Originally posted by @Matt R.:

Like David said and here is the Oahu median/average since 1985. The condos hold up nicely compared to Sfrs. 369% to condos 361%. I think Honolulu would be at least 100%+ higher than island wide.

Median & Average Sales Prices

Single Family

Year	Median Sale Price	Percent Change	Average Sale Price	Percent Change
1985	$158,600	N/A	$205,400	N/AN/A
1986	$171,200	7.90%	$211,100	2.80%
1987	$190,200	11.10%	$281,963	33.60%
1988	$210,000	10.40%	$312,300	10.80%
1989	$270,000	28.60%	$372,361	19.20%
1990	$352,000	30.40%	$498,511	33.90%
1991	$340,000	-3.40%	$432,338	-13.30%
1992	$349,000	2.60%	$411,868	-4.70%
1993	$358,500	2.70%	$436,898	6.10%
1994	$360,000	0.40%	$423,371	-3.10%
1995	$349,000	-3.10%	$429,613	1.50%
1996	$335,000	-4.00%	$409,441	-4.70%
1997	$307,000	-8.40%	$380,507	-7.10%
1998	$297,000	-3.30%	$370,021	-2.80%
1999	$290,000	-2.40%	$377,497	2.00%
2000	$295,000	1.70%	$406,331	7.60%
2001	$299,900	1.70%	$375,857	-7.50%
2002	$335,000	11.70%	$418,231	11.30%
2003	$380,000	13.40%	$479,377	14.60%
2004	$460,000	21.10%	$591,354	23.40%
2005	$590,000	28.30%	$744,174	25.80%
2006	$630,000	6.80%	$778,393	4.60%
2007	$643,500	2.10%	$794,183	2.00%
2008	$624,000	-3.00%	$792,520	-0.20%
2009	$575,000	-7.90%	$684,341	-13.70%
2010	$592,750	3.10%	$712,251	4.10%
2011	$575,000	-3.00%	$707,402	-0.7%
2012	$620,000	7.8%	$754,142	6.6%
2013	$650,000	4.8%	$804,933	6.7%
2014	$675,000	3.8%	$856,826	6.4%
2015	$700,000	3.7%	$875,373	2.2%
2016	$735,000	5.0%	$891,332	1.8%

Condo

Year	Median Sale Price	Percent Change	Average Sale Price	Percent Change
1985	$89,800	N/A	$105,900	N/A
1986	$94,000	4.70%	$108,100	2.10%
1987	$104,500	11.20%	$126,394	16.90%
1988	$114,000	9.10%	$140,377	11.10%
1989	$135,500	18.90%	$164,496	17.20%
1990	$187,000	38.00%	$225,901	37.30%
1991	$192,000	2.70%	$219,318	-2.90%
1992	$193,000	0.50%	$211,649	-3.50%
1993	$193,000	0.00%	$210,573	-0.50%
1994	$190,000	-1.60%	$210,762	0.10%
1995	$182,000	-4.20%	$206,134	-2.20%
1996	$175,000	-3.80%	$202,494	-1.80%
1997	$150,000	-14.30%	$178,090	-12.10%
1998	$135,000	-10.00%	$160,978	-9.60%
1999	$125,000	-7.40%	$157,418	-2.20%
2000	$125,000	0.00%	$165,674	5.20%
2001	$133,000	6.40%	$168,013	1.40%
2002	$152,000	14.30%	$181,933	8.30%
2003	$175,000	15.10%	$205,165	12.80%
2004	$208,500	19.10%	$251,328	22.50%
2005	$269,000	29.00%	$320,003	27.30%
2006	$310,000	15.20%	$363,639	13.60%
2007	$325,000	4.80%	$381,263	4.80%
2008	$325,000	0.00%	$383,418	0.60%
2009	$302,000	-7.10%	$346,103	-9.70%
2010	$305,000	1.00%	$359,151	3.80%
2011	$300,000	-1.6%	$357,881	-0.4%
2012	$317,500	5.8%	$374,343	4.6%
2013	$332,000	4.6%	$393,396	5.1%
2014	$350,000	5.4%	$418,186	6.3%
2015	$360,000	2.9%	$415,533	-0.6%
2016	$390,000	8.3%	$447,512	7.7%

That 2015 year for condos is odd, I wonder if that was just a coincidence..

Its nice to know your property is appreciating, but at what point does it just become a number on a screen if you don't 'realize' the gain. In the current low interest rate environment, is there a LTV or % equity figure you like to see before considering a refinance?

It seems that some of my Oahu properties are starting to creep towards 50% of the property value in equity. Given transactional costs, would you consider to refi at 50% equity? 45%?

OP

Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes

9y

Originally posted by @Alexander Monnin:

@Andrey Y. The book "What Every Real Estate Investor Needs to Know About Cash Flow" is great for learning IRR. I read it in 2-3 days and created my own spreadsheet for calculating IRR by the end of the week. Definitely worth the $10.

Where did you see $10? Cheapest I see for the 2015 version is $19 ;)

https://www.amazon.com/Estate-Investor-Financial-M...

Alexander Monnin

OH · Member since 2017 · 45 posts · 38 votes

9y

@Andrey Y.

Get the kindle version. Its $9.24, you just have to download the amazon kindle app (which is free).