How Do I Calculate My Investment Property’s Cash on Equity Return?
The Return (or growth) on Investment (ROI) has done well over the years. However, the Return on Equity (ROE), or the income from your investment property could be much better.
Here is a simplified example of computing your ROE:
1) Annual Gross Income
Monthly rent times 12 = $____________
2) Annual Expenses
Include monthly mortgage payments times 12, then add insurance, property taxes, maintenance, utilities, and all other expenses spent annually. $____________
3) Annual Net Income $____________
Subtract 2 (Expenses) from 1 (Gross Income)
4) Estimated Net Equity of Your Investment Property
(Your Realtor will assist you with this) $____________
5) To Calculate Your Property’s Approximate Cash on Equity Return, take #3 (Annual Net Income) and divide by #4 (Estimated Net Equity). This is your Investment Property’s Estimated Cash on Equity Annualized Rate of Return ____________%
Surprised? Many investors who have owned their investment properties for many years have exhausted its depreciation (a major tax benefit), and may be earning a disappointing annual return on their equity because the increase in rent has not kept up with the growth of equity.
If your annual percentage rate of equity return is disappointing, perhaps it’s time to consider…
2 possible solutions for better cash flow;
Refinance the property and acquire additional investment real estate which can grow in both ROI and ROE;
- or -
Sell and acquire superior properties via a §1031 Tax Deferred Exchange.
The §1031 Tax Deferred Exchange is one of the last tax shelters allowed by the Internal Revenue Service. It is a transaction in which a taxpayer exchanges investment real estate for other investment property which allows one to defer the payment of: Federal Capital Gain Taxes, the Recapture of Deprecation Taxes, the Medicare Tax, and California State Taxes. The IRS allows this for real property held for investment purposes, or the productive use in a trade or business anywhere in the USA. This basically includes any real estate held for investment EXCEPT your primary residence and second family home. Now you can move forward into more profitable investment property with a greater percentage of equity return (ROE) and possibly a new adjusted Depreciation schedule.
For more information, just call.
For other resources, please visit the Exchange Resources Inc. website.