Real Estate: Return on Equity
My husband and I are interesting real estate investors in that we have one duplex with a mortgage and one without. We often bat the idea around of refinancing the property we own outright. I wanted to see what the difference in return on equity was between our two duplexes, so I did some rough calculations and ignored the tax benefits. As you can see, not having a mortgage makes the cash flow for the St. Pete duplex much higher than it otherwise would be, but we are missing out on loan pay down, and the denominator (equity) is high. On the other hand, the Hudson duplex’s cash flow is low, but we are benefitting from loan pay down, appreciation, and cash flow, and the denominator (equity) is not as high.
Example: Duplex in St. Petersburg
Current Value: $275,000
Annual Loan Pay Down: $0
5% Appreciation: $13,750
Cash Flow: $15,000
Return on Equity = (Appreciation + Cash Flow + Loan Pay Down)/Equity = 10.4%
Example: Duplex in Hudson
Current Value: $420,000
Annual Loan Pay Down: $6,000
5% Appreciation: $21,000
Cash Flow: $6,000
Return on Equity = (Appreciation + Cash Flow + Loan Pay Down)/Equity = 29.5%
Do these results mean the Hudson duplex is a better investment than the St. Pete one? Not necessarily. Analyzing real estate investments requires more than one calculation. Investors also need to measure and track cash on cash return, return on investment, payback period, and more. These results do indicate the Hudson property offers better return on equity, though.
Note that we currently reside in one side of the Hudson duplex, so I ran numbers as if our side was rented.