Are you sure you’ve squeezed every last drop of profit from your equity real estate?
Whether you're a seasoned investor or just dipping your toes into the real estate market, there might just be real estate equity opportunities that get you a higher return on equity for real estate: you just need to know where to look.
Understanding Real Estate Equity
Real estate equity is the value of ownership built up in a property. It represents the difference between the property's market value and the outstanding balance of any debts or loans secured against it. Essentially, it's the portion of the property that you truly own.
Unlike debt, which entails borrowing money to fund an investment, equity represents ownership and is not required to be repaid unless the property is sold or refinanced.
Calculating real estate equity involves subtracting any outstanding mortgage balance or debts secured by the property from its current market value. For instance, if a property is valued at $500,000 and there is a mortgage balance of $300,000, the equity in the property would be $200,000.
What is a Good Return on Equity for Real Estate Properties?
Alright, so we covered the simple stuff. But what’s really a good ROE, or return on equity, for real estate properties?
Return on equity (ROE) is a fundamental metric used by real estate investors to evaluate the profitability and efficiency of their investments. It measures the rate of return earned on the equity invested in a property.
A high ROE indicates that the investment is generating substantial returns relative to the equity invested, while a low ROE may signal underperformance or inefficiency.
A good ROE varies depending on factors such as the property type, location, market conditions, and investor goals. However, a common benchmark is to aim for an ROE that exceeds the investor's cost of capital and provides a competitive return compared to alternative investment opportunities.
Calculating ROE involves dividing the property's net income by its equity investment.
For example, if a property generates $50,000 in net income annually and the equity investment is $250,000, the ROE would be 20% ($50,000 / $250,000).
In Canada, a “good” return on equity is around 5-7%.
Tips for Maximizing Your Return
Property Improvements
Now, let’s talk about maximizing your return on equity for real estate properties, starting with property improvements.
You have to be strategic when investing in upgrades and renovations. When it’s done right, investors can increase the property's appeal, attract higher-paying tenants, and ultimately boost ROI.
Plus, you’ll be able to attract higher-paying tenants, increasing your monthly cash flow and return on equity.
But over-improving a property relative to its market value or neglecting essential maintenance is a real thing– and it can lead to diminishing returns.
Investors will often conduct thorough cost-benefit analyses and prioritize improvements that offer the highest return on investment. They’ll also consider the property’s location, and if higher-paying tenants are willing to come to your property based on the neighborhood and the surrounding area.
Some common property improvements are:
Upgrading kitchens and bathrooms
Installing energy-efficient appliances
Enhancing curb appeal through landscaping
Modernizing interior features such as flooring and lighting
But remember, take this with a grain of salt, and pay close mind to whether your property improvements show promise of a high ROI, or if they’ll just look pretty without yielding any reward.
Refinancing
Refinancing presents another avenue for you, the real estate investor, to optimize return on equity by leveraging lower interest rates or accessing additional equity.
Through refinancing, you can replace existing debt with a new loan that offers more favorable terms, like lower interest rates or longer repayment periods.
Of course, this would be great if it means lowering your monthly mortgage payments, accessing equity for property improvements or additional investments, and consolidating debt are among the benefits of refinancing.
However, timing is crucial when it comes to refinancing. If you want to go this route, you need to be on top of monitoring interest rate trends and market conditions can help investors identify optimal refinancing opportunities.
And remember– refinancing isn’t free! Consider the costs associated with refinancing, including closing costs and fees, to make sure that the potential benefits outweigh the expenses.
Diversify Your Portfolio
You can minimize your investment risks by spreading investments across multiple different property types, geographic locations, and investment strategies.
This means investing in residential, commercial, and industrial real estate, as well as exploring opportunities in different geographic markets.
But while diversification can offer amazing financial growth, you’ll need a lot of in-depth market research, expertise in multiple property types, and effective portfolio management strategies.
You should know the potential trade-offs between diversification and concentration risk before diving into this, or you might find yourself overwhelmed with too many investments, biting off more than you can chew.
Get a Real Estate Partner You Trust
Ultimately, the key to getting a high return on equity for real estate is working with a partner you trust!
Reach out to CRE Professionals today for real estate advice and consultations so you can make your next real estate decision with confidence.
Frequently Asked Questions
What is preferred equity in real estate?
Preferred equity in real estate is a form of financing that occupies a middle ground between debt and common equity.
Investors providing preferred equity typically receive priority over common equity holders in terms of distribution of profits and repayment in the event of liquidation.
Unlike debt, preferred equity doesn’t involve fixed interest payments, but investors often receive a predetermined preferred return before common equity holders receive any profits. An investor can structure preferred equity in various ways, offering flexibility in terms of risk and return for both investors and property owners.
What is private equity in real estate?
Real estate private equity involves investments made in privately held properties or real estate-related companies. Private equity firms pool capital from institutional investors, high-net-worth individuals, or pension funds to acquire, develop, or reposition real estate assets.
Private equity and real estate typically involve a longer investment horizon and higher potential returns compared to publicly traded real estate securities.
What are some considerations when evaluating preferred equity or private equity investments in real estate?
Risk profile: Assess the risk-return profile of the investment, considering factors such as the property type, location, market dynamics, and capital structure.
Capital structure: Understand the terms and structure of the preferred equity or private equity investment, including the preferred return, distribution waterfall, conversion rights, and exit strategies.
Track record and expertise: Evaluate the track record, expertise, and reputation of the investment sponsor or private equity firm. Consider their experience in executing similar investment strategies, managing risk, and generating returns in various market conditions.
Market dynamics: Assess market conditions, trends, and potential risks affecting the target market or property. Consider factors such as supply and demand dynamics, economic indicators, regulatory environment, and competitive landscape.
Due diligence: Conduct thorough due diligence on the underlying property or portfolio, including financial analysis, property valuation, tenant analysis, and legal review. Identify potential risks, opportunities, and mitigating factors that may impact the investment's performance.
Exit strategy: Evaluate the potential exit strategies for the investment, including sale, refinancing, or recapitalization. Understand the timeline, liquidity options, and potential obstacles to executing the exit strategy successfully.