If you have more than 50% equity in your investment property you may find this writing of value.
By Bart Pebbles
Caliber Retail Properties Group
Return on equity invested is one of the key fundamentals in real estate financial analysis. Return on Equity,sometimes referred to “ROE” or Cash on Cash return is one of the base measures of investment performance. A simple calculation determined when dividing Cash Flow by Equity.
A common instance with investment property can occur over the course of the investment’s holding period when even though the asset “cash flows” satisfactorily to the owner, in reality Return on Equity “diminishes”, actually going down with each passing year.
The below table illustrates this occurrence. Column 1 depicts a “Subject Property” that was purchased 10 years ago for $1,000,000. The investor put $400,000 down and placed debt in the amount of $600,000, This investment realized a 1st year pre-tax cash flow of $31,832 yielding an initial Return on Equity of 7.96%. A nice investment return realized in its initial year.
Fast forward 10 years to “today”. Column 2 looks at how the Subject Property is performing today. Yes, rents have increased over time thus increasing pre-tax cash flow, and principal loan balance is reduced through amortization by almost $100,000. All is good right? Well, not exactly. When we take a closer look, we discover Return on Equity is actually going down significantly every year.
Some say, “sitting on money is losing money in the big picture” and this table shows that very clearly.
What to do? Perhaps refinance and buy an additional investment? Perhaps sell and exchange? Columns 3 and 4 considers two options if the property could sell for a capitalization rate of 6.5% (or lower)? If so, the property’s value today would exceed $1,500,000. The difference of today’s value and the original purchase price is $500,000 and that amount is sitting, not performing for its investor in any way.
What are an investor’s primary objectives? These vary of course with every investor but could include.
1. Is it my objective to maximize my return?
2. Is it my objective to live on the cash flow from the property?
3. Is it my objective to use some of the cash flow for other purposes while at the same time maximizing my return?
Objective to Maximize Return on Equity?
This objective dictates the investor will use leverage (Debt) to maximize return, particularly when interest rates are at today’s historic lows.
Objective to Maximize Cash Flow?
This objective will dictate the investor buys an investment property, put as much cash as they can into it, then use the cash flow for whatever purpose they require.
It is important to understand in this event,the Investor will earn less than one-half of the return they could if they maximized leverage (Debt).
Objective to Achieve “A Little Bit of Both”?
This objective speaks for itself.
Prepare an Annual Asset Business (Investment) Plan.
Of the many benefits of a written Asset Investment Plan is that it serves as a tool to shed light on potential options to better reach objectives. Options identified in Columns 3 and 4 in the above table include refinancing the asset and using some of the equity gained in the Subject Property to either exchange into another property or continue to own the “Subject” and purchase another investment.
This analysis is merely one reason to formally assess your investments annually.
Is Your Retail Property Operating at Its Highest Potential?
Property owners sometimes grow comfortable with their asset’s condition, not tapping into current market opportunities, are resistant to change, or just unsure whom can efficiently execute a program to improve tenancy, investment return and enhance overall value.
Expiring Leases, Bankruptcies, Vacancies, and Dated Retail Concepts do indeed present temporary challenges, but they also can present opportunity.
Certainly, the current Pandemic has created turbulence. To optimize performance, to stabilize and strengthen, and ultimately to maximize value, experience and vision counts now more than ever!
Caliber Retail Properties Group offers a 30-Year track record in delivering market-leading expertise and providing “best-in-class” development, asset repositioning, leasing, and sales services of retail, and mixed-use properties.
Our experience and problem-solving solution strategies are highly conducive to handling challenging assignments and properties in today’s marketplace. We offer a “fresh set of eyes” perspective in maximizing investment performance, executing innovative repositioning, and leasing programs.
We welcome an opportunity to discuss your specific needs and design a program to achieve your goals.
Founder & President
CALIBER RETAIL PROPERTIES GROUP