Understanding Return on Equity – Example

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Investors sent in their property lists. And we are going to figure out which ones to unload first based on my rules of return on equity. So for those of you guys don’t know what return on equity is, it is a metric that not a lot of investors go by. But I and a lot of other sophisticated investors monitor very closely as we’re always pruning our investments, a big misnomer out there that people talk about a lot is buy never sell, which I think is half true. investors need to look at return on equity and figure out which assets to sell, refinance, or maybe use a HELOC on, basically you’re trying to find her dead are lazy equity, that’s not doing anything. And we are going to go down this list, I’m going to show you how to do this in this little example. 

But like when you first buy a turnkey rental, you’re making around 30%. At least I’m thinking, you can check my math here at school passive cash flow, calm slash returns. And I walked through a little whiteboard example showing everybody exactly how I come up with that with cash flow, mortgage, paid down tax benefits, and any bit of appreciation. Let’s go through this list right here. And let me show you how you manipulate this spreadsheet. Again, this is one of the cardinal sins that most investors make is they never sell and they have a huge equity position, which tends to happen over time. But they need to get that equity moving. One of the biggest mistakes I always hear is like well up cash line, it’s like, well, yeah, your cash flowing a lot. But your return on equity sucks. So you got to do something about it. 

So this investors very smart, they realize that they need to get this equity working hard, certainly harder than that at their day job. And we’re going to help them do that. So first formula I’m going to do here is just setting the status, all right, the value of the property is $1.1 million, what I’m going to do is I’m going to apply a 90% multiplier, just assuming that maybe this is just a little bit too high, and to account for closing costs and commissions. From there, we are going to subtract the debt service, so they currently own $352,000 on this property. And that is how we come up with a rough estimate of how much Lacey debt equity. So I’m going to cascade that down a spreadsheet.

Just cut and paste that down. And I’m just gonna sub this up to see how much of a problem we have here.

So about $2.3 million in equity. And on some kind of one to see a high level what we’re we’re at, actually, I have to figure out the some of the values of the property minus the some of the bolts course I’m missing out the Commission’s but I just kind of want to see where we’re at. So that’s 2.8. So that’s how much those loans and commissions and closing costs, whether or not that loans but the commission closing costs are what I call friction costs, are taking out almost half a million dollars right there. 

Maybe one day, I’ll be one of those douchey luxury real estate brokers and only work with clients selling two to $3 million houses, maybe I don’t want to do that with my life. But anyway, figuring out, let me sell them. This is the amount of equity and this is the amount of purchase price. So I’m gonna go this number divided by this. And currently there are right about on average 57% equity, which is not good. Usually, at full power, you’re going to be at 80%, just to typically be the max leverage, but it’s definitely getting to the side where I mean, it’s a good thing, you got a lot of equity, but it’s a lot of debt equity. So next process is like alright, figuring out which of these properties that we need to go first. So what I’m going to do is figure out what the how much money we’re making money we are paying

for via let’s just go by that. So on this first one, we make money with the rent. So that’s the primary residence to start off with.

This one’s bringing in 5000 bucks a month. And I’m also going to subtract these he wastes they put it down. And this is the reason why we don’t like conference. So you always have to pay these things. I don’t know exactly what this means by extra costs here, I’ll just add subtracted and also subtract out the Buffy mortgage peanuts, I would run these numbers a little bit differently. But that’s good enough for government work is what I say. That is how much money they are making believe on a must be on a monthly basis. So let’s multiply that by 12. So they’re making 30 grand. So you want to take that their return on equity is calculated by how much money you’re making, divided by how much equity you have in the deal. So if your denominator which is the number at the bottom goes up, which in this case, it’s the $475,000 this number gets smaller. It’s

smaller, so they’re making about 7% on this property right now, that’s not good. So as we cascade this stuff down, there were a ton of equity on the primary residence is obviously zero, because not making any money, you’re probably losing money, that is a liability, right? They’re not an asset for these properties actually losing money. But to the pier, here’s kind of where the art comes into play, you can either look at it from perspective, all right, which property has the worst return. And so that is obviously this one and this one here, but we’re humans, and this is art. 

So obviously, like, there’s some utility to having a primary residence because that’s where your, your house resides. And that’s where you live. So maybe you don’t want to sell that one. First. Again, we’re trying to find the border operations border that we got load, so or refi. The next thing I’ve kind of take into account secondly, after the return on equity is how much equity requires you to extract out of it. So if you know say, this one, we’re losing the most amount of money, this is probably first on the chopping block. But because it’s so small, it’s not may not be worth the effort. And likely, what we want to do is we want to list multiple properties on the market. And kind of the attitude of you know, some of them were more in a hurry to sell some we might fold out for even better price. So the way I would do this kind of spot checking this is the first time I’ve seen this, the first two that stick up in my head are this one. And just I want to highlight the lowest three from a return equity perspective, but I want to highlight the big ones, which ones are going to really move the needle. And that is, which ones are the ones with the biggest bang for our buck, which is definitely these three. So fortunately, there’s no overlap here, other than the primary residence as a primary residence, that’s probably have to go but I don’t want to upset mama bear. 

So we’re just gonna leave that one on gone, we’ve got plenty of equity to play with here. So there’s no obvious winners, which ones to put on the chopping block, but just kind of I’ve done this buttock a zillion times. And what I would recommend selling would be this one first may not be the lowest return on equity, but it’s certainly a nice little pop there. And I would sell this one, but then I would sell this one, and I would sell this one, this one, these are all kind of the same. And then at some point, when a boss says, Okay, I guess or what do you take maybe one of these rentals, take the money and buy a bigger house, right? So this is where you buy a mansion does a good job up to this point, right? I mean, this is where people say, Well, you shouldn’t buy all this like do dads or like expensive stuff, but man like you earned it, you did a good job here, go out and buy a big ass house for all I care. Next, what I’m looking at is an act. This is probably where we got to get the investor on the line. I don’t know the full story on these properties. I don’t know what all these are, to be honest, these duplexes and fourplexes, maybe stick on the market owner occupied. Now even though I list them as five, knowing that these gonna, these are going to be four times as hard to sell as these other single family holds. And this is why for higher net worth investors, I don’t recommend getting a two to five unit. I just say if you’re going to do single family homes, it’s great because you have great exit strategy. As a high net worth investor you’re going to go to syndications very quickly. So you don’t want to be screwing around with this stuff. Because the the duplexes and triplexes fourplexes huge send it selling it to the cheapskate investor who wants to find the deal and their pain, you’re just gonna bang your head on the wall, especially when you get to one of these guys who are like think that they’re a pro, but they’re just a douchebag, who wants to retreat you for all these little nitpicky stuff. So I would list even though I haven’t listed as five, I probably list it like soon just and not be too motivated to sell it. Somebody wants to pay your crazy price for B and that’d be my general consensus with all these properties right here. Just put them all on the market, see what happens. 

But generally, you’re trying to go make a go at this order. This is really your motivation. Whereas when I’m saying like these guys, they just want to sell it, or they want a little bit of a price concession do Just do it. Or as these other ones you might want to stick to your guns or stick to your price that you think that it’s valued out here. The other side of this is like alright, where as you start to extract this money out this money right here, it’s $2.3 million. You can’t it’s got to be hard to invest that in the beginning, especially if you have no contacts. You don’t know who to trust, but you’re basically you’re trying to do is build a appointment schedule right here and I’m just doing it very simplistically, you know, you got 2020 2021 2022 for most investors under one to $2 million dollars net worth. I’ve never done any rental properties never syndication before. I would say no stick to like a few deals at first, right? That’s 15 grand minimums, and maybe deploy to

hundred thousand dollars in the first year. But after that, hold the horses a little bit right pump the brakes. Of course, if you have if your net worth is higher than that for $5 million plus this, the other side of you got money sitting in the bank doing nothing, right. So you may want to push it a little bit harder being more aggressive. Now this is a just in time exercise here, you want to sell these acids and hot potato them into deals, minimizing the full period or the time it just sits in a bank not doing anything. So I would imagine selling these properties probably in a period of two to three years. It’s taken a while. 

So I’m just gonna run the rental value ratios real quick on these properties to say I probably should have done this earlier. But this also helps determine another way of determining which properties to model first. She besides the probably the best right here. These other ones are well under 1%. Yeah, on both of them should unload him yesterday, people always ask like, Well, I have a rental property in California. And I’m like, Alright, stop right there. rents value ratios, California ain’t gonna work unless you’re in a war zone. To get more nitty gritty here, it’s if it’s under 1% to value ratio on load, unload that thing, it’s just not even worth it. Especially when a lot of you know other properties that we’re buying, like, you know, one well over 1% of the value ratios in broad markets with force appreciation. So I guess for this client, this client is pretty high net worth. So I would probably make this deployment schedule a little bit aggressive. So assuming that a cash saw half a million dollars every year on this. And so all the assets by the time 2024 comes around, I probably do something like 500 grand, that’s roughly kind of like the how you would patient deployment schedule. 

And this is where other more advanced concepts come into play. And like, you know, to lower your bid put me not making anything like infinite banking, which users will life insurance in a tax free via goal. Yeah, this just shows an example on figuring out your return on equity. What are you trying to sell first? And then what are you trying to deploy it into? Another piece of this is where I help clients all the time, and where I kind of empower people in the mastermind. And you can learn more about that it’s simple passive cash flow.com slash Johnny. But it’s like you know, you don’t want to sell these assets, you got to be mindful where number one your adjusted gross income is, you don’t want to be looking up into the next tax bracket. And guys, if you’re under 200 $300,000 AGI, don’t freak out about it. Most of my clients are well above that, that’s when you have to seriously think about no BGG con when you sell these assets and kind of take the capital gains slowly over time. And then also, if you’re, you know me, you may be taking money out of your retirement accounts too. That’s another thing to think about. So when you take money out your retirement accounts, it also shows up as ordinary income. So another thing that’s at play here is you have a portfolio like this, you would likely have a good amount of passive losses from the depreciation of these. 

But you also have to, as I go into this, it’s complicated, right? But it’s just something is what I do, right, this is what I do for folks and help them understand it so they can make their own game plan. But as they start to deploy into these deals, hopefully they’re doing cost segregations. In these deals, where they’re getting at least half of what they put in to inject brand, they load up 200 grand in deals that hey, Bobby should be getting more than $100,000 of passive losses, which they can add to their current passive loss, a stock fold to then use to offset these capital gains, but they do happen to that’s kind of getting three layers deep there. But these are the things to be aware of. And I think every investor needs to understand that. I don’t think that this is the responsibility of your CPA, like the CPAs job is to do your taxes for you. Not plan this stuff. This is your job guys, family offices, on millionaire families and above, people that do this for you. But look, when you’re under 10 million bucks, you got to do it all yourself. And fortunately, most CPAs out there just don’t know how to do it because that’s why the CPA has a day job off. their net worth is not over 123 $9 they don’t do this stuff. 

And that’s where we can kind of help but for free freebie go to simplepassivecashflow.com/ROE to download a spreadsheet very similar to this is more of a worksheet that you can plug your investments in and see where you have your lazing equity at to help you determine which properties to sell. What’s the poop down here what needs to go? It’s an unlock sheets the spreadsheet you guys can have. So you can again search out that debt equity and don’t be an unsophisticated investor that just buys properties and holds it till it’s paid off. I think that’s one of the worst things you can do especially from like a liability standpoint. I mean, if you have a paid off property, everybody knows where to see. Yeah. And that gives me

Tax any legal advice here this whole video but just giving you guys good information and yeah check out what we have to offer it simple passive cash flow calm. See you guys later bye!

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