RETURN ON EQUITY “How hard is your investment working?”

The question as to when to sell an investment property depends on many factors, including: the likelihood of future appreciation, the cash flow it produces, the ease or difficulty of managing the property, and the property’s fit in an investor’s overall investment portfolio. A real estate investor should not overlook a simple measure to determine how hard their invested dollars are working: the property’s “Return on Equity.” By analyzing return on equity, a real estate investor can compare a particular property with other potential investments in an effort to maximize the return on their investment equity. 

Example: A small fourplex was purchased several years ago on very favorable terms. It produces a nice cash flow that resulted in an extraordinary 20% return the first year. Even with the following assumptions, which would produce a high return on equity, the return falls to less than 5% after 7 years.

•  10% down payment
• 90% Loan-to-Value (LTV), 7% fixed mortgage over 30 years
• Appreciation at an average of 4% per year
• Annual net income increasing by 2% per year

Year      Value         Debt (7%)       Equity    Equity % Value   Annual  Net Inc.   Return on Equity                                                                                                            

1         $300,000   $270,000           $30,000         10.0%                 $6,000                     20.0%

2         312,000     267,020             44,980            14.4%                6,120                      13.6%

3         324,480     264,062            60,418            18.6%                 6,242                      10.3%

4        337,459     260,890              76,569            22.6%                6,367                       8.3%

5        350,957     257,489             93,468             26.6%                 6,494                      6.9%

6         364,995     253,842             111,153          30.4%                6,624                       5.9%

7        379,595     249,931              129,664          34.1%                 6,756                       5.2%

8       394,779     245,737               149,042           37.7%                6,891                       4.6%

9       410,570     241,241               169,329          41.2%                 7,028                       4.1%

10     426,993    236,419               190,574          44.6%                  7,168                        3.7%

 

  As evidenced in the chart above, the investor in this example has a return on equity that starts diminishing significantly after about 7 years of ownership. In order to continue obtaining a much better return on invested equity, an investor should consider exchanging this one investment property after 5-7 years and acquiring multiple replacement investment properties. Later on, the investor will benefit again by exchanging these investment properties and exchanging into more (or larger) properties with leverage that will continue to produce a higher return on their equity.

For question on Grand Junction real estate or Grand Junction investment real estate, contact Andrea.

Andrea Haitz, Broker Associate
“Taking Real Estate to New Heights”
Heiden Homes Realty and Associates
970-245-7777 office
970-201-3578 cell
www.AndreaHaitz.com

Used with permission from:

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