Educational tool. Not an offer, solicitation, or advice.
How the ROE Calculator works
Return on equity asks what the money you have tied up in a property is producing right now. This page states the formula, works two examples, and defines the terms. The interactive ROE Calculator runs the same arithmetic on your own numbers.
The formula
In words: take a year of gross rents, subtract a year of operating expenses to get net operating income, subtract a year of debt service to get cash flow, then divide that cash flow by the equity you currently hold. Equity is the current value of the property minus the total debt against it.
NOI = annual gross rents - annual operating expenses
cash flow = NOI - annual debt service
equity = current property value - total debt
return on equity = cash flow / equity
Monthly entries are multiplied by twelve before anything else happens, and the same rule is applied to every flow figure. Entering 3,500 monthly and entering 42,000 annual describe the same year and produce the same result. Return on equity is undefined when equity is zero or negative: Return on equity divides your cash flow by the equity you hold, so there is nothing to divide by until your value is higher than your debt.
What this measure excludes
Return on equity here counts cash flow only. It excludes principal paydown and appreciation.
Both can matter to an owner, and neither is cash in hand this year. Mixing them into this ratio would answer a different question and make two properties financed differently incomparable. They are left out so the number means one thing.
Worked examples
The inputs below are hypothetical, chosen to show the arithmetic. They are not market rates and not results anyone obtained.
Example 1: a single rental, entered monthly
A property carrying debt, with the flow figures entered the way a monthly statement reports them.
| Property value | $400,000 |
|---|---|
| Total debt | $260,000 |
| Gross rents (monthly) | $3,500 |
| Operating expenses (monthly) | $1,200 |
| Debt service (monthly) | $1,600 |
| Annual NOI | $27,600 |
| Annual cash flow | $8,400 |
| Equity | $140,000 |
| Return on equity | 6.0% |
The equity in this property is producing the cash flow shown. Entering the same year as annual figures gives the identical result, because the period toggle is an entry convention and not a change to the arithmetic.
Example 2: more cash flow, lower return on equity
The same rents and expenses as Example 1, but the mortgage is gone and the property is carried at a higher value. Cash flow rises because there is no debt service; equity rises by more.
| Property value | $600,000 |
|---|---|
| Total debt | $0 |
| Gross rents (annual) | $42,000 |
| Operating expenses (annual) | $14,400 |
| Debt service (annual) | $0 |
| Annual NOI | $27,600 |
| Annual cash flow | $27,600 |
| Equity | $600,000 |
| Return on equity | 4.6% |
Cash flow here is more than three times Example 1 and the return on equity is lower, because the denominator grew faster than the numerator. That divergence is the whole reason this measure exists: a property can pay more and still be working its equity less hard. It is the arithmetic behind the term dead equity.
These figures are a mathematical calculation based on your inputs. They are not an estimate of future performance.
Definitions
- What is return on equity on a rental property?
- Return on equity is annual cash flow divided by current equity. It asks what the money you have tied up in a property is producing right now, rather than what the purchase price once produced. In this calculator it is a cash-flow measure: it excludes principal paydown and appreciation.
- What is equity in this calculator?
- Equity is current property value minus the total debt against it. It is a balance, not a flow, so it carries no monthly or annual period. Return on equity is undefined when equity is zero or negative, because there is nothing to divide by.
- What is net operating income (NOI)?
- Net operating income is annual gross rents minus annual operating expenses, before debt service. It describes what the asset produces independently of how it was financed.
- What is cash flow here?
- Cash flow is net operating income minus annual debt service. It is what the property puts in the owner pocket over a year, on the numbers entered.
- What is dead equity?
- Dead equity is equity that is producing little or no cash flow. The term names a diagnosis the arithmetic can show; it is not a recommendation. What to do about it is a decision for the owner and their own licensed professional.
- What is margin of collapse?
- Margin of collapse is how far income can fall before it no longer covers debt service. It is a stress reading taken from the numbers entered, describing headroom rather than predicting any event.
- Why does return on equity exclude principal paydown and appreciation?
- Both can matter to an owner, and neither is cash in hand this year. Mixing them into this ratio would answer a different question and make the figure incomparable between two properties financed differently. They are excluded so the number means one thing.
Run it yourself
Open the ROE Calculator to enter your own figures. The same calculation is also available as a read-only JSON endpoint at /api/public/roe, described by /api/public/openapi.json.
Educational tool. Read this first.
This is educational only. It is not an offer, a solicitation, or a recommendation to buy, sell, lend, or invest. The figures below are hypothetical and based on the numbers you entered. Any percentages shown are historical or comparative reference data, subject to market conditions. They are not a projection, a forecast, or a promise of future results. Alchemist Nation is not registered as an investment adviser. Talk to your own licensed professional before making any financial decision.