There are two ways of approaching the topic of return on equity (ROE) as it applies to real estate investments. In each of them, “return” has the same meaning: cash flow after taxes (CFAT). What differs is the meaning of "equity". In the traditional method, the equity is your initial cash investment. For this assignment we had to use the alternative technique, of taking the initial cash plus the additional equity that has built up due to amortization of the mortgage and to the increase or in this case decrease in the value of the properties.
How to calculate?
- First Method: Return on Equity=Cash Flow after Taxes/ Initial cash Investment
- Second Method: Return on Equity= Cash Flow after Taxes/(resale Value less Mortgage Balance)
Our Advisor met with the client and presented to them the findings. The client was able to see instances when the ROE was declining, and was confronted with the question: Is it the best use of my money to have it tied up as equity in this property? It is not a rhetorical question-maybe it is the best use in some cases- but in those scenarios where it didn’t make sense the client was advised to consider refinancing to take cash out and reinvest or to sell outright and reinvest into a different, perhaps larger property.
As a result of our ability to underwrite and analyze these type of properties we were able to guide this client on all of his properties in this small 60 million dollar portfolio. Results were, lower rates, refinanced in some cases 80% LTV, maximized cash out in others, and from there our Advisor continued to worked with the client on additional properties that were purchased as a result of the freed equity.