If a property produces good cash flow, it will certainly improve the ROE, but it becomes difficult to really account how to best use the money up to a certain point. You can start paying back some of the loan early (increasing your loan reduction portion of the ROE) or just accumulate it until you get enough to buy another property, or just keep it in your rainy day fund. It’s akin to tracking your dividends for stocks, where after awhile you just lose track of them. While I try to keep up with my paperwork, it is best to just keep the number as simple as you can.
The ROE number itself has so many components and there are so many ways to approach your real estate investing. You can concentrate on certain parts, like the cash flow and the tax basis in order to get a true calculation. At the beginning, the ROE is a useful “generic” number that can help you choose properties based on their potential. Later on, when you purchase the property and start working through it, you can re-calculate the ROE and see how it actually performed.
And each part of the ROE can change over time or have specific calculations unique to certain properties. For example, properties in the Hurricane Katrina hit zone can be depreciated faster, so their tax basis is different than any other property around the country.
As far as equity going up to infinity and all, the downpayment portion of the ROE will always stay generally the same, because that is what you put into the property at the beginning. Everything else after that becomes part of the return. Even if you pay off the donwpayment, the results of that will show up on the cash flow portion (because the loan interest you’ve been paying on the downpayment part would be part of the cash flow). There are programs where you can put 10% or 5% down, and that can increase your ROE to a huge degree.
Anyways from dictionary.com:
equity – the monetary value of a property or business beyond any amounts owed on it in mortgages, claims, liens, etc.
Paper equity or not, it is still a real value but it does and will fluctuate or time.
