Christian Osgood and Cody explain why return on equity matters more than ROI when deciding whether to hold or sell rental properties. As equity builds, ROE often declines, making the asset less efficient. If cash-on-cash return falls below 8%, they recommend rolling that equity into a larger property that yields more.
Chapters
Hello YouTube, we're back and this week we're talking about return on equity. Specifically, when is it time to look at either 1031ing or selling a property that you have and rolling it into the next asset? At some point you may have so much equity that while you have a great initial return on investment, the money will make more sense deployed elsewhere.
Too many people focus and prioritize these 3 magical letters called ROI, return on investment. That is the big thing everyone's focused on. What's my ROI? Well, some folks, they'll go out and burr properties and they'll say, well, it's an infinite return because I have no money in. And we're here to share with you that return on investment and return on equity are two very different things. If you have no money in a property and you cash flow every single month, Your return on your investment's pretty good. It's infinite. You have nothing in it.
I like infinite deals.
Infinite deals are wonderful, but the problem with that is you're likely to have equity because you earn returns based on equity. So if you own a piece of real estate, let's say you bought it way back when. You bought it for $100,000. You did the VA thing, and you're in at $0 down. You did your VA loan owner occupied, and today it's worth $200,000. You're cash flowing $200 a month, $300 a month, that's wonderful, you have no money in it. However, your $200 to $300 a month cash flow, if it went up $100,000 in value, that's on $100,000 in equity. Your return on equity is terrible. So we need to figure out when do we actually go and transition.
Now Cody, specifically, how do we calculate return on equity? For those who aren't familiar with the actual math behind it. How do we actually quantify what is my current return on equity?
Well, whenever we're looking at a return, whether it's cash on cash return, you're looking at your ROI, or you're looking at return on equity, you're just going to divide the amount of dividends it pays you, your cash flow, into, in this case, the equity you have in the asset. Typically folks look at, okay, if I invest $1,000 and at the end of the year I got $100 in cash flow, I made a 10% return on investment. Well, instead of looking at what we invested, let's look at what do we have as far as equity ownership in the property? Because equity builds over time. You have these wonderful tenants, they'll pay off your loans, and properties go up in value if you buy in the right locations. So you take a look at, okay, what's it worth today? What do I owe? You subtract the debt from the asset value, and now you've got Equity. If you owe $600,000 on a million-dollar property, you have $400,000 in equity. And typically what happens is you start paying down your loans and the property starts going up in value. Your return on the equity that you have gets lower and lower and lower because your leverage is lower. And so as you're playing this game, you got to figure out, okay, well, when do we actually make that adjustment?
That makes sense. For me, when I'm buying, so going on initial return, that ROI you mentioned earlier, That initial going-in ROI on a duplex I have, I always target over 8%. The particular deal I'm thinking of was closer to 25-30%, but 8% is my personal minimum. That property, we had major improvements going into the property, we got excellent rent, and the market we're in appreciated incredibly. So I went from having just a little bit of equity in the property, about $50,000, to having about $160,000 in the property. That changes your math a lot when you go from $50K to $160K. Well, now that money can be redeployed. I've hit a lot of the upside available on that duplex. It's been improved. It's getting those rents. We have an opportunity in one of Cody's 12-plexes where he is letting me buy in. That has a bunch of upside. We're using that capital to improve that building. I get to ride up on another improvement project. And get a higher return on the same equity that we just created in the other asset. So when you're looking for when is my jumping off point, a good benchmark for me is if your cash-on-cash return has fallen under 8% return on your equity, that equity probably can be doing more in another property for you.
Yep, and that can just be through maybe a cash-out refi, pull a little bit of money out, Don't spend the principal, reinvest it into assets that will pay you. Or if you don't want to just keep leveraging up an asset, let the asset keep paying itself down or sell it and go buy something a little bit bigger. As you build your equity, like Christian did on the duplex, he is transferring his equity from a duplex into a 12-plex. The equity multiplied, which is our big thing. We don't want to just add, we want to multiply. Then there's a transition. I'm going to take what I built, what I multiplied, I'm going to move it up into something bigger. And let it start over. Now we have a new basis. We're going to multiply that basis on something that's much bigger, 6x bigger in this case. And granted, his cash flow will probably stay the same day one, but now there's a new future upside because he's buying again on a value-add opportunity where he can take his $160,000 and turn it into $480,000.
Yeah. Now if you follow this channel at all, and if you don't, you should do it right now. But if you follow us at all, there's two principles that we always buy on. How do I buy it? How do I own it? And how do I never lose it? How do I keep this property forever? Some of you might be wondering, well, doesn't that violate your principle on how you acquire property? No, I still could keep this property forever, and it still could cash flow forever.
And it cash flows a lot compared to the amount of debt he has. His debt coverage is insane.
That being said, You can still redeploy and grow your portfolio. There are transitions that you will make naturally throughout this. What you need is the power to choose to buy or sell when you want to buy or sell. When you have acquired the property, if you don't want to sell it, you don't need to. Having control over that— say the market went way down and the rents pulled back and some of that appreciation went away— that might not be the right time for me to unload that asset and roll it to the next project. And just the timing might not be there. So as long as you can buy right and hold it forever, you then get the luxury of getting to choose when do I want to sell it. This, looking at the whole return on equity, is a luxury that you get to have because you invested well and you held your property till the right time.
And it's a luxury that we get because we don't violate our principles. How do we buy? How do we never lose it? The cash flow on these assets is phenomenal, which means that our equity will multiply because we're getting great returns. Most people don't need 25% cash on cash. They're willing to take a little bit of a drop. Yeah. And so he knows that he has a margin there. And so when we follow our principles, it gives us options. And it's why we want you to follow those principles as well, because at the end of the day, if you know that you will never lose the asset based on cash flow, you're set. When you can hold indefinitely, you're set because real estate does go up over time. We have this government who's going to keep printing money. They just can't seem to stop. So reap the benefits of that and play the game at the highest level.
Yeah. And recap from today: do the math. What is your current equity? What are you bringing in at the end of the year? What is your final cash flow on that property annualized? Divide that out, see what your return is. If it's not where you want it to be and you know you can redeploy that in assets that are yielding more in your market, it may be time to roll up. If you guys have any questions on this, always feel free to comment below. We will elaborate, and if we missed anything in this video, we are happy to include it on Wednesday for Whiteboard Wednesday, where we'll answer 5 questions from the comments. If you haven't already, like and subscribe below. Thanks for watching. We'll see you guys soon.
