Return on Equity (RoE) is a measure of the return received from the investment property compared to the equity in the property, expressed as a percentage. It can be calculated on the first years ownership based on the amount invested divided by the cash return.
How do work it out?
For example, a purchase of a $300,000 property with $60,000 of your own money, or 20%. In the first year of purchase, you see that the property is worth $300,000 but you only owe $240,000. Now if you were able to achieve a $5,200 positive cash flow per year after all expenses (excluding any tax or depreciation benefits). Our RoE is calculated as $5,200 divided by $60,000 = 0.867 or 8.67%.
Now fast forward 10 years and you’ve been paying down that loan and the property has increased in value to $500,000. Your mortgage has dropped from $240,000 to $200,000. Your equity position is now $500,000 minus $200,000 = $300,000. Plus the rent has gone up and you’re now making $10,000 positive cash flow per year. Now to calculate the RoE again in year 10 it is as follows: $7,800 divide $300,000 = 0.333 or 3.33%.
As the equity has increased faster than the rents could go up, the RoE drops. This is still a great investment as you could take your excess equity in the property, in this instance its $200,000 as the bank will probably only allow you to draw down up to 80% of the value at $500,000, and invest in yet another property, or 2.
Luke Jorgensen - Lush Property
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