What is your Return on Equity?
Rental Property Investor · San Diego, CA · Member since 2014 · 1k+ posts · 2k+ votes
Hi all,
Has anyone here ran a calculation of your return on equity? To do so, you take the current cash flow and you divide that by equity you have in your RE. So your personal home has little to no ROE. Right? It is a liability.
Plus, if you live in a place like I do, San Diego, you most likely have a lot of equity tied up in your Multifamily and personal residences. I have $5,000,000.00 in RE and about $2,500,000 in Equity. I cash flow approximately $120,000 per year. So, $120,000 divided by $2,500,000 or about 5% return on equity (ROE). Now I expect that cash flow to rise to $160,000 in the next 3-6 months, due to repositioning projects. That will put my ROE at approximately 6.5%. That is more like it.
What is your return on equity? Let us know here!! If you have an extremely low ROE, let me know by personal message and we could communicate and I could give you some suggestions to get yours much higher!!
Swanny
ROE is a big metric in securities. In RE I think it is weak. If you own a property free and clear, the ROE is low, in fact it is not calucable. If you owed a lot of money on the property, it would be higher. This assumes you redeploy the equity into another income producing asset. Leverage skews the numbers.
It is simply one data point, that is not enough information. The question is what do you want the data to tell you? Sell, refi etc?
I look at:
rent multipier - allows a comparison of disparate properties, regardless of asset class, finance,location.
Cap rate - using current market and original purchase price
NOI - How much money do I have left at the end of the month
Alternate finance options - refi?
Alternative use of the money. Could I realize a bigger return somewhere else?
Tranaction cost
I'm about 6%. Don't want to share the two numbers that make that up. Part of that "low" number is the value of the properties have gone up faster than the cash flow. If you have a property that doubles in value, but rents don't go up the same amount, you'll end up with a lower ROE (which isn't necessarily a bad thing -- which is why I never really consider or calculate ROE)
Also, I could easily refi and take out more cash, which I haven't done yet as I want my cash on hand to match my need for it.
If I was to cash out more, that would lower my property equity, and raise my ROE
Hi @Cody L.
Or........... You could 1031 exchange to invest in another emerging market that you could get greater cash flow and force more appreciation. Right? I chose that option, due to my worry about the inflated values of San Diego Single family, befor we have another correction and they start to ease up Dodd Frank and they start to give loans to morons again.
Swanny
Or...... Refinance as you suggest and just make sure you still have about 60-70 percent debt on the property and still have some safety if a pricey area does have a major correction and you don't go upside down on your loan.
Swanny
Hi @Cody L.
Or........... You could 1031 exchange to invest in another emerging market that you could get greater cash flow and force more appreciation. Right? I chose that option, due to my worry about the inflated values of San Diego Single family, befor we have another correction and they start to ease up Dodd Frank and they start to give loans to morons again.
Swanny
I'm doing a-okay. I have plenty of liquid cash to buy what I want, when the deals come, but not so much cash that I'm paying on debt while keeping those proceeds in the bank making 1%
I don't 1031
I don't invest in San Diego.
I've been buying smart in Houston, doing refi on appreciation to take my money back out and rearm myself for the next deal. I've bought 200+ units in the last 6 months. I'm now over 1000 in the last 10 years. Almost every property I've bought has at least doubled allowing me to sell for a large cash event or (more typical) refi to keep doing more of the same.
That is great @Cody L.,
Refi to financial freedom plan. Way to go!! 1000 front doors or more is my goal. I want 50 million in RE, 15 million at least in net worth and $750,000.00 to $1,000,000.00 in cash flow. Was that your goal at one time?
Swanny
That is great @Cody L.,
Refi to financial freedom plan. Way to go!! 1000 front doors or more is my goal. I want 50 million in RE, 15 million at least in net worth and $750,000.00 to $1,000,000.00 in cash flow. Was that your goal at one time?
Swanny
My goal has changed a lot. The # at which I thought "I'll be done" has moved. Since I still like it, why stop?
My goal has changed a lot. The # at which I thought "I'll be done" has moved. Since I still like it, why stop?
that's an awesome attitude. Personally i think goals should always change once you have achieved them. you are obviously doing something right.
Once it becomes work or a chore it's time to find another passion.
You know what? Me, my wife, and my parents went in on these 86 front doors together. If we did not have $700,000-$800,000 current equity in our personal residences, we would have that money invested in another $75,000-$100,000 cash flow per year too. I could live anywhere and rent for $3,000-$4000.00 a month and not have to pay a $2,000 mortgage every month on my personaL residence with $300,000 left on the loan, like I do now. Just a thought. My wife would never go for it. Of course my parents would never sell there house and take about $600,000 tax free and down size to a condo or a much smaller house and rent.
That is the way my mind works though. My house is just a liability that was built i. 1971 and I need to start socking money into it as it ages.
Swanny
@Michael Swan I haven't bought any investment properties yet, so I got a long ways to go with that.
But felt like chiming in since your story reminded me of my wife. After pestering her all the time about being more frugal, she one day randomly told me we should sell our primary (built in '72), and throw a mobile home on her dad's property (vacant 3 acres). I'm all for downsizing after we hit 2 years if the market is in a good place for us to sell, but thought it was pretty funny she was so down to not only downsize, but even go for a mobile home (I'd rather stick with downsizing to a smaller house myself haha).
Yep!! That would be tough. Buy some rental properties and become financially free!! Now if you sold and temporarily lived in a mobile home park to build up your cash flow, that would be another story. As Dave Ramsey says, "Live like no one now, so you can live like no one later."
Swanny
Yep!! That would be tough. Buy some rental properties and become financially free!! Now if you sold and temporarily lived in a mobile home park to build up your cash flow, that would be another story. As Dave Ramsey says, "Live like no one now, so you can live like no one later."
Swanny
Been looking at rentals a bit, but now that my wife is getting serious about going back to work, it's more realistic to purchase one now. The reason I plan to wait two years to sell, is that we won't have to pay any capital gains tax since we will have homesteaded for the previous two yrs. We also purchased at a price point where there would be some cash flow as a rental if the market was down, not great, but I ran the numbers on it so I would know of alternatives to sell. Never heard the quote until now, but I've always been frugal - got it from parents, but they just lacked the investment side of things and are scared of risk. I got tired of putting all my money into the stock market and that's how I finally ended up here.
Are you guys using this ROE formula?
Formula for ROE
Annual Cash Flow + Net Increase in Property’s Equity
Divided by
Accumulated Equity Prior to Year
Includes net sale proceeds after tax as if you were to sell at each years end. One might see a higher or lower REO% but a more accurate accounting picture of ROE.
Hi @Matt R.
You make a good point. Although, I can't expect much more appreciation in San Diego. As you know, I don't like to speculate. I can do that with the stock market. I have no control if the market goes up on my single family in San Diego. I do have control of increasing the NOI, value of the property, and cash flow of my apartment complexes in Ohio. So yes, I could use your calculation or a more precise calculation on my apartment complexes. Basically, if I increase the NOI by $1.00, the value of the complex is $10.00 more than I paid. So, four of my complexes, I have increased the NOI by $8,000, $10,000, $5,000, and $9,000. That means those apartment complexes have increased their value about $420,000 total in a short 7 months to 20 month period. Not to mention that cash flow is rising dramatically too. They are not valued by comps like single family are valued. I like the control it gives me on valuation and cash flow is amazing too.
Swanny
@Michael Swan I get the point behind your point, truly. I assume your answer to @Matt R. question, though is, "No." If you're uncomfortable with including market appreciation in that calculation, is there a reason you're not at least including the equity earned through those principal payments in addition to the annual free cash flow when calculating this?
The definition for "ROE" is well established, so using an alternate definition causes confusion. And, it includes any tax-related gains or losses. I don't know how to differentiate "Official ROE" and "Layman's ROE" in posts like this.
Also, @Cody L.'s first reply has an important nuance that may be missed - it's very difficult to increase the ROE on a portfolio using the OP's formula, and it's often a bad thing if it does. CAP rate decompression, like negative fluctuations in the SFR and small MFR markets, is real and can be a *****.
ROE is a big metric in securities. In RE I think it is weak. If you own a property free and clear, the ROE is low, in fact it is not calucable. If you owed a lot of money on the property, it would be higher. This assumes you redeploy the equity into another income producing asset. Leverage skews the numbers.
It is simply one data point, that is not enough information. The question is what do you want the data to tell you? Sell, refi etc?
I look at:
rent multipier - allows a comparison of disparate properties, regardless of asset class, finance,location.
Cap rate - using current market and original purchase price
NOI - How much money do I have left at the end of the month
Alternate finance options - refi?
Alternative use of the money. Could I realize a bigger return somewhere else?
Tranaction cost
Hi @Matt R.
You make a good point. Although, I can't expect much more appreciation in San Diego. As you know, I don't like to speculate. I can do that with the stock market. I have no control if the market goes up on my single family in San Diego. I do have control of increasing the NOI, value of the property, and cash flow of my apartment complexes in Ohio. So yes, I could use your calculation or a more precise calculation on my apartment complexes. Basically, if I increase the NOI by $1.00, the value of the complex is $10.00 more than I paid. So, four of my complexes, I have increased the NOI by $8,000, $10,000, $5,000, and $9,000. That means those apartment complexes have increased their value about $420,000 total in a short 7 months to 20 month period. Not to mention that cash flow is rising dramatically too. They are not valued by comps like single family are valued. I like the control it gives me on valuation and cash flow is amazing too.
Swanny
Nice and I hear ya. The ROE number is not speculative when calculating the annual past performance. One could still project ROE returns. That is another seperate consideration imo.
For the sake of discussion...it is possible your personal residence is part investment if that home appreciates above and beyond inflation. For some in Cali or others like Cali this might be a 7 figure number over time to account for. If we look at Warren Buffets Laguna Beach vacation house for example this became an 8 figure return or 7000% return and without doing airbnb:)
ROE is a big metric in securities. In RE I think it is weak. If you own a property free and clear, the ROE is low, in fact it is not calucable. If you owed a lot of money on the property, it would be higher. This assumes you redeploy the equity into another income producing asset. Leverage skews the numbers.
It is simply one data point, that is not enough information. The question is what do you want the data to tell you? Sell, refi etc?
I look at:
rent multipier - allows a comparison of disparate properties, regardless of asset class, finance,location.
Cap rate - using current market and original purchase price
NOI - How much money do I have left at the end of the month
Alternate finance options - refi?
Alternative use of the money. Could I realize a bigger return somewhere else?
Tranaction cost
As investors and stewards of our family's savings, allocation of personal capital is one of the most important financial decisions we make and ROE is very important in helping to make that decision. It reveals the productivity of your capital. Things like ROI and cash on cash are not helpful a couple of years post-acquisition.
ROE can be calculated on free and clear properties. The denominator is the current property value.
You can purchase at a great cap rate and GRM and have a poor performing investment relative to other investment alternatives (for example, without the use of leverage). Direct investment in real estate is too much work to not achieve outpaced returns relative to other asset classes.
Many investors analyze the heck out of a deal at acquisition but then do not subject their portfolio to the same criteria post-acquisition. It's even more important with appreciation plays and the need to reassess frequently once your appreciation strategy has happened. There can still be long runway and you hold...or maybe you exit. The idea is to be intentional and follow a plan; otherwise, you are at the whims of the market. Some appreciation plays are also very long term plays and you just roll with with the interim fluctuations.
Once it becomes work or a chore it's time to find another passion.
I just wrote that one down. It applies to many other things in my life aside from real estate. But I go to networking meetings just about every weekend, and I learn something every time. There are more fun things I could be doing on my Saturday, especially since I am strictly a passive investor these days, but I keep going because it never feels like work to me. As soon as it does, I'll slow down and be more passive in my passive investing.
To answer the question...my one rental property has lousy cash flow, and I have a lot of equity in it, so I guess my ROE is close to zero. So why do I hold on to it? The appreciation and amortization increase my net worth by five figures every year. As someone said on this thread already, the ROE isn't always a great metric in real estate.
To the "your home is a liability, not an asset" crowd: even though your home doesn't generate any income, what if the cost of living there were less than the cost of renting an equivalent place? That scenario is likely in a high cost area if you bought the house ten years ago, or bought it at a significant discount somehow, even after factoring maintenance and CapEx. Isn't the cost savings over renting equivalent to putting money in your pocket?
Hi @Matt R. , @Justin R., @Lesley Resnick, @Mike Dymski, @Kevin Coggins, @Cody L. etc...,
Great discussion so far. In early 2015, I did the quick ROE that I mentioned and realized my 10 pricey RE Condos had virtually doubled and I was still only making about $4,000-$5,000 total cash flow per month on Condos I purchased in San Diego in 2011 and 2012. I was at the mercy of the HOA associations for those monthly fees too. Plus, since my parents went half in on all these deals with my wife too, that wasn't enough to replace my W2 family income.
When that quick calculation proved was I was getting barely 3% ROE, I knew I needed to get that equity out. Many of you know my story.
I then proceeded to 1031 exchange from the single family business model to the Multifamily business model with an initial goal of simply replacing my W2 earnings of $80,000 combined family W2 earnings, as a teacher, working 60 hours a week at a Catholic School and a few evenings a week as an adjunct professor.
Now I have traded in that equity and now have $10,000 per month or $120,000 per year, through the power of the 1031 exchange and am OUT of those escalating HOA fees for the most part. That cash flow is rising at a rapid rate. Of course we split that with my parents, since we both invested half the seed money.
Also, we have one more condo we are listing to sell right after 4th of July here in San Diego for about $280,000 that we purchased in 2011 for $116,000 I believe and trading that in for another 20 unit plus that cash flows about $20,000-$25,000 a year and a few other of our apartment complexes, we already have have been repositioned now and should start throwing off about $3,000-$4,000 or $36,000-$48,000 more cash flow a year too.
One year from today our goal is $200,000 or more cash flow per year. Not to mention forced appreciation by increasing the NOI.
My area of San Diego that I live in is a solid middle class "C" type area and the highest my personal residence ever appraised at was $500,000 and it is about $20,000 under that valuation now. Plus, the rental condo I am selling soon is also in a "C" class neighborhood and is approaching its highest valuation of $295,000 ever.
So, in these neighborhoods I am talking about in San Diego, people need to make enough money to pay for the mortgage etc...
Nobody can pick the peak of any market for single family. So, I am sticking to the plan, except for keeping my personal residence and my parent's single family residence, who live in a little higher class neighborhood "B" class in the San Diego area. My personal residence went down to a $270,000 value during the Last RE crash. I have about $300,000 left on my loan on my personal residence.
By me running this ROE calculation I took action and am now financially free. If I lost one or both of my jobs, how long could I last?
Forever!!! That's especially true in about 12 months time.
All of you have really stated some important points. Depending on your particular life circumstances, the area you live and invest in, performance can vary dramatically based on your time horizon and strategy implemented.
Happy Fathers Day!!!
Swanny
ROE does have some use, I just never really use it for the purpose of what I do in this space.
It is worthwhile to look at the total equity you have in properties (their current value minus your debt) to see how all that equity is performing. If it's low (sub 5 or 6% let's say) then you might be better off selling your properties, and taking that cash/equity, and doing something more productive with it.
I like the idea of $50m in property (not equity, just pure property value regardless of debt level) "making" me a $1m year in equity gain due to an expected 2% rise from inflation alone.
Understood Swanny. I think as mentioned some rely more heavily on ROE factors to make decisions in more straight up liquid type investments vs REI. There are more hidden factors with REI for many to consider like job growth, supply and demand, gentrification etc...imo it is entirely another ball game that way and dimishes ROE as the primary investor influencer when compared.
Happy Fathers Day!
My ROE using the formula presented by @Matt R. in San Diego has historically been very good but the last couple of years not as good as the previous 4 or 5 years.
This has been achieved due to various actions/decisions as well as market appreciation.
I attempt to minimize equity. Most of my properties were re-financed in 2016. As long as the rates remain low I will refinance to pull equity out of when it makes sense. Due to this most of my properties are at or near 75% LTV.
The next big factor is the appreciation that allowed @Michael Swan to be able to 1031 his San Diego properties after they appreciated to other markets. The appreciation in San Diego has averaged a great return.
In general, we purchase properties with sweat equity opportunities. We look for at least 50% return on our sweat equity (I.e. A $15k rehab we want $22.5k net value for a $7.5k return.
Like all investors we seek below market purchases. This is easier said than done (assuming you do not want to sit on the sidelines) but we have completed some below market purchases.
Another item that contributes to my good ROE is a duplex that cash flows at an incredible rate due to rents of $200 to $350/day per unit (STR) and near 100% booking (so $400 to $700/day rent for both units). This is a managed property so we do not get all of the rent.
Another item is my long term rentals (excluding my ex-residence) were purchased for their income producing potential. They are c class area duplex to quads that get conventional loans (low interest, long term). They are not units I would choose to live but they are nice units for working class people and we rehab them nice enough that we target the preferred tenants of our potential tenant pool. My ex-residence (nor my current residence if converted to a rental) cannot compete with the ROE on these investment purchases. I would be surprised if any condo in the county could.
The conventional loans at the current rates produce better equity pay down than virtually any other time in history. This ends up being significant but historically would have less significance.
Add them up and San Diego has provided us a very good ROE over the years.
Good luck.