What is a Return on Equity Percentage

11 Replies

What do you guys think is a solid ROE number and why?  I listened to the BP podcast and they were talking about this.  I have had more appreciation then I would have expected which has skewed the ROE in a good way but assuming it levels off to 3% I would be around 15% ROE.  Personally I am trying to become financially independent and am willing to take on some extra work and risk to reach it.  If I leveraged up to 25% equity again I could reach around 25% with all of the same assumptions.  In your opinion would an extra 10% ROE be worth it to you?

Thanks for humoring me,

@Eric Bilderback Are you talking about a refi to crank back equity(cash) into your pocket? That lowers your cash invested and will increase your cash on cash return. It also increases your return due to appreciation from a cash invested perspective. I've had this conversation tons of people. I think the best way to be is fully leveraged or free and clear, no in between. When you pull out equity, to invest the cash, it has a snowball effect. You can buy more or payoff something else. Your risk of loss for that property decreases. If your refi gets all your cash back, now your risk of investment lost is gone. Plus, your bank is a partner in a down market, when you are fully leveraged. Your bank may become your advasary when your 50% leveraged and times get tough. On the flip side, it sure is safe to keep property free and clear. Separate your eggs. Take risk with some that you have very little in that could break. Keep the paid off ones in safe spot.

@Eric Bilderback , it might be a big mistake to rely on "all of the same assumptions", going forward.

Yes, you've enjoyed great appreciation thanks to Banks making lending easy, (almost desperately), for lower and lower interest rates due to competitive forces. But remember: "Past performance is not indicative of future performance"!

The answer to your question relies on your answer to another question: How will you invest the money you borrow against the equity you've built up? ie. What risks are you prepared to take on? Only you can answer that! Good luck...

@Jason Dillard

Jason I would be interested in hearing why you made the statement that a bank is a partner in down market when using lots of leverage, but is an adversary when 50% leveraged?  Not sure I understand why that would be?  

Appreciation typically reduces ROE unless the rents rise as fast as prices, which is rare. But return on investment (ROI) gets a big boost as does IRR. I look at ROI/IRR as the real measures of success. Its also most comparable metric when comparing different types of investments.

@Jim Goebel , I found that statement interesting too! If I dive into it a little bit, we know that banks don't really want to be buyers and sellers of real estate but if you have paid off most of a property (say 50%) and you foreclose or for some end of the world reason, the bank calls you to pay off your debt now and you can't they can profit more on the resale of your property once they foreclose. If you still owe them a lot and maybe they want to foreclose on you and sell or auction the property, they aren't going to profit much from that situation since they are still owed (say 70%)

@Jason Dillard I like your way of seeing threats and advantages from both sides!

@Jim Goebel 100% leverage means you owe too much for bank to foreclose. Bank may defer payments, modify loans, or lend more for improvements. You really don't have much to loose here. 50% leverage gives opportunity for bank to take and get all their investment back without being flexible. You could loose tons in this position.

@Jason Dillard

@Mark Burik

I wanted to circle back to this after doing some thinking on it (your statement that a more 'exposed' position is to have 50% leverage vs 100%).  Another perspective as I understand it, is that a lender makes more money (from interest) during the first part of a loan.  Further, the terms of a loan are pretty straightforward generally- ie: make the payments and you satisfy the note.  I guess if we are talking about situations where one is not making some of their payments, or unable to - then wouldn't it follow that an owner should ensure they are making their payments on their 50% leveraged property as they have more to lose in having it taken?

On the surface I get your reasoning but in practice I'd be wanting to see concrete examples of actions by a bank / lender that suggests opportunism.  The further risk to a bank's image/brand in being opportunistic in this regard I see as another motivating factor here.

Examples welcome though! I'd like to hear more. We are pretty equally leveraged right now and have 2 properties we essentially own outright, (one under IRA) and then the rest are in that typical 60-80% range with regards to our leverage.

My justification right now for not continuing to lever up (ie: buy more move in ready to rent properties) is that after another probably 6 purchases roughly we have little investible funds.  I value the flexibility to pursue other business interests.  I also see the market as inflated.  But, it may continue upwards still!

@Jim Goebel Why do you need cash to keep buying more? Maybe today your best move is to hold your cash and current debt load. Some will pay off soon and others you don't feel comfortable leveraging up today. By the way, I had a 2m 70% LTV loan call due last ression. It wasn't for non-payment. The debt coverage put us out of line with the morgage covenants. Moving on, shelve your portfolio for a year and then revisit. In the mean time, are you happy staying stagnant? For some reason, we just keep buying more. Maybe the reason is, we are full time, and I don't have a fall back job. The more we have, more potential cash flow, is another reason. Until we sold some bigger stuff and "had to" put off the tax by doing 1031's, we didn't make down payments. We don't make down payments on 99% of our deals even now. We don't feel limited by not having a down payment. As a matter of fact, we aren't limited by monthy payments on our flips and new construction either. We just create deals with private lenders that have loans that accrue. Come to think of it, we bought 40 condos last year(no down). Plus, we are under contract for 82 houses today with a structure that doesn't require a down payment. Ok, it's decided. You keep what you have, just the way you have it. You start buying deals with no down payments and/or monthy payments.

@Jason Dillard

Great point about the LTV. I never realized they could call your debt I thought they had to wait for the end of the term of the loan. I want more cashflow but your logic is solid don't touch and now down payments got it!

Thanks for the advice,

@Jason Dillard

Thanks for the thoughts and input on our situation.  I think I understand most of what you're communicating.  With regards to the 'calling a note' we I do not think are at risk of that.  I'd have to double check but I believe only once so far we've utilized a commercial note (shorter term and some language allowing a lender to use discretion, balloon terms, etc) and it was only briefly.  We are locked in in mostly 15 and 30 year long term fixed notes for our mortgages.  I guess it'd be good to triple check that and make sure there isn't anything in there regarding debt service ratio staying above a thresh-hold, like yours. 

I'm not sure we can even find a lender in this area that would do no money down notes on investment properties.  I could be wrong, but that doesn't add up to me.  The other consideration now is that I don't see us building much (if at all) equity purchasing into the existing market.  Especially factoring in my return on time, I'm more motivated right now to sit on the sidelines, to be honest.

I'm wondering if a fundamental difference in your options are getting into the volume you're doing as a broker (vs what we're doing).  I'm also wondering the impact this has on your lending options. 

I might be missing something entirely but when I think broker, I think brokerage, IE real estate agents, buy/sell agents, etc.  Sure, there are some properties sitting on the market for a while but most are closed within a few months of listing.  What am I missing?  Are you holding/operating these properties?  How'd you get into the volume you're doing Jason?

@Jim Goebel When I sign up for bp, I disclosed I'm a broker. However, I began as an investor that got my license later. We do own a brokerage, but I don't take clients personally unless they are looking to trade their commercial properties. How do we buy so many deals? We advertise for sellers to call us, we buy from other wholesaler's, we make a ton of offers, and I attend a marketing session almost every month. Why aren't we concerned about equity at first without down payment? It's because when we buy all cash, we get equity to begin with. We only make offers that are 75% or less of the value. How can we borrow 100% of our purchase price and rehab? We also make offers to private individuals (or thier SDRA'S) to borrow money at 70-75% of ARV. I make just as many offers to borrow money as we do to buy houses. I actually do this with a radio show every Saturday morning at 8. It's a live call in. If we get terms from seller like a Sub2 or something, then we may give them some money. Finally, the marketing session. This is where you can multiply all of your efforts. I am a seminaraholic. I read real estate investing books for fun. I have attended local Reia meeting for 10 years. I live, sleep, drink Real Estate. Nothing compares to a marketing session. I have learned more at a marketing session, and its is not a seminar. The power of collaboration and knowledge that is shared will blow your mind. Now, it takes a while to understand how it works. It took me a year to start to get it. Today, I can use one to buy the property that the other broker couldn't move. The formulas that are used at a marketing session works at home. It makes you specialized and gives you more tools to buy with. Your competition goes away or calls you for help on their harder deals. Change your brain. Don't be normal.