 The question as to when to sell an investment property depends on many factors, including: the likelihood of future appreciation, the cash flow it produces, the ease or difficulty of managing the property, and the property's fit in an investor's overall investment portfolio.
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A real estate investor should not overlook a simple measure to determine how hard their invested dollars are working: the property's “Return on Equity.” By analyzing return on equity, a real estate investor can compare a particular property with other potential investments in an effort to maximize the return on their investment equity.
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Example: A small fourplex was purchased several years ago on very favorable terms. It produces a nice cash flow that resulted in an extraordinary 20% return the first year. Even with the following assumptions, which would produce a high return on equity, the return falls to less than 5% after 7 years.
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· 10% down payment
· 90% Loan-to-Value (LTV), 7% fixed mortgage over 30 years
· Appreciation at an average of 4% per year
· Annual net income increasing by 2% per year
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Year
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Value
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Debt (7%)
|
Equity
|
Equity as
% of Value |
Annual
Net Income |
Return
on Equity |
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1
|
$300,000
|
$270,000
|
$30,000
|
10.0%
|
$6,000
|
20.0%
|
|
2
|
312,000
|
267,020
|
44,980
|
14.4%
|
6,120
|
13.6%
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|
3
|
324,480
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264,062
|
60,418
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18.6%
|
6,242
|
10.3%
|
|
4
|
337,459
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260,890
|
76,569
|
22.6%
|
6,367
|
8.3%
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5
|
350,957
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257,489
|
93,468
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26.6%
|
6,494
|
6.9%
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6
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364,995
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253,842
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111,153
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30.4%
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6,624
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5.9%
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7
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379,595
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249,931
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129,664
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34.1%
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6,756
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5.2%
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8
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394,779
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245,737
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149,042
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37.7%
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6,891
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4.6%
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9
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410,570
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241,241
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169,329
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41.2%
|
7,028
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4.1%
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10
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426,993
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236,419
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190,574
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44.6%
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7,168
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3.7%
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11
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444,073
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231,249
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212,824
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47.9%
|
7,311
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3.4%
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12
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461,836
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225,705
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236,131
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51.1%
|
7,457
|
3.1%
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13
|
480,309
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219,760
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260,549
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54.2%
|
7,606
|
2.9%
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14
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499,522
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213,385
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289,137
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57.2%
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7,758
|
2.7%
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15
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519,502
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206,550
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312,952
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60.2%
|
7,913
|
2.5%
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16
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540,282
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192,220
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348,062
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64.4%
|
8,071
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2.3%
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17
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561,894
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191,361
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370,533
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65.9%
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8,232
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2.2%
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18
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584,370
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182,934
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401,436
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68.6%
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8,396
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2.0%
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19
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607,744
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173,897
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433,847
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71.3%
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8,563
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1.9%
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20
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632,054
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164,207
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467,847
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74.0%
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8,734
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1.8%
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As evidenced in the chart above, the investor in this example has a return on equity that starts diminishing significantly after about 7 years of ownership. In order to continue obtaining a much better return on invested equity, an investor should consider exchanging this one investment property after 5-7 years and acquiring multiple replacement investment properties. Later on, the investor will benefit again by exchanging these investment properties and exchanging into more (or larger) properties with leverage that will continue to produce a higher return on their equity.
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E. Frank Wade, Broker Associate and Keller Williams Realty does not give tax or legal advice. The information contained herein should not be relied upon as a substitute for tax or legal advice obtained from a competent tax and/or legal advisor..
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