Return on Equity
January 30, 2013
Posted by on
Many people focus on making money from cash flow, appreciation and potential tax benefits. Today, we will look at another attribute of investing in real estate that is sometimes, but not necessarily, researched properly before refinancing. The idea is known as Return on Equity.
The equity in a property is the difference between the loan amount and the fair market value of that property. This equity that belongs to the owner has the potential to be used as investment money for future projects. The question is when should the owner use the equity to invest in that next project and when should the equity be left in the asset and not touched.
Mortgage rates are near record lows and job prospects are improving plus there is an increase in housing starts. Mortgage lenders such as Wells Fargo, indicate that in the next 12 months there will be an increase in housing prices, activity in sales and in housing starts, even though the U.S. economy is slow to recover. For more information on the significance of this, be sure to take our Rich Dad Education Elite Creative Financing Course.
So when should the owner consider using the equity in one asset to purchase another asset? When the Return on Equity meets their criteria! That means the return they receive on their equity is greater than the return they receive from other types of investments i.e. stocks, bonds, etc. The Return on Equity is calculated when you take the annual cash flow plus the annual appreciation and divide that by the equity that is left in the asset.
To do this, an investor would first calculate the Return on Equity on the asset before they refinance to see what the return is. Second, the investor would then do the same Return on Equity calculation after they refinance to see what that return is. There is one additional piece to the puzzle. The investor will also calculate the Return on Investment on the money used to invest in the next project. If the Return on Equity after refinance plus the Return on Investment added together are greater than the Return on Equity before the refinance, then that is the time to refinance and move the equity into the new investment.
To find out more on how to take advantage of your equity, consider taking our Rich Dad Education Elite Creative Financing Course.
Richard Maryanski and Erik Maryanski
Rich Dad Advanced Elite Trainers and Mentors