Calculate Return on Equity (ROE)

Rainsby
Feb 12, 2021
Jan 28, 2022
Being a property investor it is always important to know how efficient your own invested capital is employed. This capital can be referred to as owner's equity in contrast to borrowed capital, which usually are loans from a capital lender, for instance your financing bank. The net rent minus all expenses, your profit, divided by the owner's equity is the return on (owner's) equity, usually in percent.
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Equity
Equity
The equity capital is the amount of money out of your own pocket that you use to buy an investment property. The opposite of equity capital is borrowed capital, which you get for instance from your bank as a loan.
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Rental Income
Basic Rent
The basic rent is the rent paid for the usage of the property and is defined in the rental agreement. The basic rent does neither include operating expenses nor maintenance costs. Alternative names for the basic rent are net rent, base rent or net rental income.
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Costs
non-transferable Operating Costs
The non-transferable operating expenses can be found in the annual statement. The non-transferable expenses are paid by the landlord or landlady and are stated in the German regulation on operating costs (§1 BetrKV). Costs for the administration of the property are for instance part of the non-transferable operating costs. You may find similar regulations in your jurisdiction.
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Maintenance Fee
The maintenance fee is only taken into account in the calculation of the return, if you provide a value for it. It provides a more realistic view on the net return and is relevant for the cashflow. The value for the maintenance fee may be found in the documents of the annual statement of the property provided by the property management.
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Financing Costs
If you decided to finance your investment property, you will have to pay an annuity to the bank which consists of the redemption rate and the interest payments. The redemption rate pays off the credit. The interest payments are collected by the bank as a fee for providing the capital. To calculate the return on equity, you only need to provide the interest payments.
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Result per Year
Return on Equity per Year
The return on equity (ROE) is calculated as follows:
$$\text{ROE} = \frac{\text{(basic rent - expenses)} * 100\%}{\text{equity}}$$
The expenses per year consists of the non transferable operating costs per year, the maintenance fee per year and the interest payments for the loan:
non transferable operating costs per year
+ maintenance fee per year
+ interest payments
expenses per year
%
Income minus Costs per Year
helpMessage.profitPerYearForEquity
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Total Costs per Year
The total costs per year consist of the non-transferable operating costs and - if provided - the maintenance fee. However, in real life there may pop up additional costs for instance for repairs.
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Result per Month
Income minus Costs per Month
helpMessage.profitPerMonthForEquity
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Total Costs per Month
Average total costs per month.
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1. Which input parameters are required to calculate the return on equity?

Please provide the complete employed owner's capital, the basic rent and the non-transferable operating expenses and the interest on your loan. The input for the maintenance fee is optional.
You can choose to plug-in either monthly or annual values, for the financial costs (only the interests) you can choose a monthly, quarterly, semiannually or annually time frame.

2. What is the significance of the return on equity?

The return on (owner's) equity (ROE), is a measurement on how efficient you invested your own money. In principle you need the employed capital, the earnings and expenses (net income) to calculate the return.

3. How much of your own capital should you invest?

To answer this question it usually is a good idea to evaluate the risks involved and your constraints as an investor. Although there is no general answer to that, the following considerations might help you with that process:
Having a more closer look at the mathematics, we notice that the return on equity increases to infinity, if we let the equity go to zero, keeping the net income constant. This makes perfectly sense in the way that in this case we create a return out of basically nothing. Practically however, this would be the case where you completely finance the property with borrowed capital. If we consider a low owner's equity to borrowed equity ratio as more risky, then the ROE can be used as a risk and leverage indicator. The more risk involved, the more it is important to carefully plan and calculate your investment, especially the cashflow. At any time you should be able to pay back the interests of your loan, no matter if you have expensive repairs or maintenance or even a loss of rent on your property.
If there is no borrowed capital involved in your property investment, then the return on equity is identical to the net return, since the price of the property as well as the additional costs when buying a property are paid out of your pocket. In this case the risk is considered lower and your leverage is lost. We conclude that the lower the amount of your employed capital the higher is your return on equity and therefore your leverage and of course the risk, assuming we keep the net income fixed.

4. How do you calculate the return on equity?

The return on equity per year is calculated as follows:
$$\text{return on equity} = \frac{(\text{basic rent} - \text{operating costs}) * 100\%}{\text{owner's equity}}.$$
The basic rent as well as the operating costs are on a per year basis.
The operating costs per year consist of the non-transferable costs and the maintenance fee.
non-transferable operating costs per year
financing costs (interests) per year
+ maintenance fee per year
operating costs per year

5. Is the return on equity constant over time?

No, the return on equity changes over time in general. Reasons for that are increasing or decreasing rents, changing operating expenses and if you have changing interests on your financing e.g. on an annuity loan - due to the regular redemption payment the owner's equity increases over time, while simultaneously the interests decrease.
If we consider an annuity loan, two effects occur. First, since you have a fixed annuity consisting of interests and redemption payments the interests decrease gradually and if we keep the owner's equity constant the ROE then increases, assuming all other variables remain fixed. However, we could argue that by having to pay the redemption payments we increase the equity, the owner's capital really, which would result in an overall gradually decrease in ROE until the loan is fully paid back. In this case, your cashflow over that time period would stay constant since the annuity is usually constant.

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