Apollo AdvisingReturn on equity: the rental number most owners never check
How to calculate return on equity for a rental, why it drifts down as a property appreciates, and what it does and does not tell you about selling.
Short answer. Return on equity is a rental's annual net cash flow divided by your equity, which is the market value minus what you owe. A rental worth $450,000 with a $150,000 loan that nets $9,000 a year is earning 3% on its $300,000 of equity, before appreciation and loan paydown.
The calculation
Equity is what the property would sell for today minus the loan balance. Net cash flow is a year of rent minus every operating expense, the full mortgage payment, and a reserve for repairs and capital items like roofs and HVAC. Divide the second number by the first.
Use today's value, not what you paid. Return on equity asks what the money tied up in the property is earning now, which is a different question from how good the purchase was.
Check what your equity is earning
Type over the figures with your own property.
3.0%
is what your $300,000 of equity earns each year in cash flow, before appreciation and loan paydown. That is $3,000 a year for every $100,000 tied up in the property.
Why the number drifts down
As a property appreciates and the loan is paid down, equity usually grows faster than rent. A rental that earned double digits on its down payment in year one can earn under 4% on its equity fifteen years later, even while its cash flow more than doubles. Nothing went wrong. The money simply piled up inside the property.
Cash flow grows from $5,780 to $13,188 a year, but equity grows from $50,000 to $356,464, so each dollar of equity earns less. Assumes a $250,000 purchase with 20% down, a 30-year loan at 4.5%, rent of $2,300 a month rising 2.5% a year, expenses and reserves at 35% of rent, and 5% annual appreciation. Illustrative, not a forecast.
Show the numbers
| Year | Value | Equity | Cash flow | Return on equity |
|---|---|---|---|---|
| 1 | $250,000 | $50,000 | $5,780 | 11.6% |
| 2 | $262,500 | $65,726 | $6,228 | 9.5% |
| 3 | $275,625 | $82,226 | $6,688 | 8.1% |
| 4 | $289,406 | $99,537 | $7,159 | 7.2% |
| 5 | $303,877 | $117,699 | $7,642 | 6.5% |
| 6 | $319,070 | $136,755 | $8,137 | 6.0% |
| 7 | $335,024 | $156,747 | $8,644 | 5.5% |
| 8 | $351,775 | $177,723 | $9,165 | 5.2% |
| 9 | $369,364 | $199,730 | $9,698 | 4.9% |
| 10 | $387,832 | $222,819 | $10,244 | 4.6% |
| 11 | $407,224 | $247,045 | $10,804 | 4.4% |
| 12 | $427,585 | $272,462 | $11,378 | 4.2% |
| 13 | $448,964 | $299,129 | $11,967 | 4.0% |
| 14 | $471,412 | $327,108 | $12,570 | 3.8% |
| 15 | $494,983 | $356,464 | $13,188 | 3.7% |
That is why long-time owners are often surprised by this number, and why it is the first thing we look at in a hold or sell conversation.
What it leaves out
Return on equity is a cash-flow measure. It does not include:
- Appreciation, which may or may not continue in your market
- Loan paydown, the part of each mortgage payment that builds equity
- Tax effects such as depreciation, which your CPA can quantify
- What selling would cost: commissions, closing costs, and taxes on the gain, including depreciation recapture
So a low number is a reason to look closer, not a verdict. A full analysis puts cash flow, paydown, appreciation, and the cost of selling into one picture.
What owners do with it
Once you know the number, the realistic paths are usually these: keep the property as it is, raise its income with a strategy change, pull equity out with a refinance or HELOC, sell it, or exchange it under Section 1031. Each one changes cash flow, risk, taxes, and the time the property takes.
Whether 3% is enough depends on your goals, your taxes, your time, and what else the money would do. Comparing that number against stocks, bonds, or other securities is investment advice, which Apollo Advising does not provide.
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Go deeper
When a 1031 exchange does not make senseSix situations where paying the tax can beat deferring it, and how to run the comparison.Cash-out refinance or HELOC on a rental?How each one works on an investment property, what they cost, and the cash flow test to run first.Depreciation recapture: the tax most rental sellers forgetWhat recapture is, why it applies even if you never claimed depreciation, and how to estimate it before you list.This page is general education, not legal, tax, investment, insurance, or lending advice. See our disclosures.