With 2021 behind us and eviction moratoriums coming to an end, investment property owners ready to make a change are evaluating new opportunities and often planning to perform a 1031 Exchange. Many owners are motivated to sell because of the increasingly demanding regulatory environment. Others are selling because of lifestyle changes, and the desire to eliminate active management and improve cash flow potential.
However, before deciding to sell, it is important to know your property’s cash flow performance metrics, which can be viewed in two ways: the first is as a Return on Investment or “ROI” and the second is as a Return on Equity or “ROE.”
Calculating Investment Property ROI
Return on Investment tells an owner how well their original investment performed during its life. Calculation of this metric is done by comparing the net cash flow (rental income, less operating expenses, and debt servicing costs) over the years to the original investment made in the property (often the down payment on the property plus any significant capital expenditures that improved the property). ROI is a key metric an owner can use when asking themselves, “Was this a good investment?”
Calculating Investment Property ROE
To capture your property’s appreciation and compare 1031 Exchange replacement property options, we turn to the Return on Equity metric. Return on Equity is calculated by comparing the earlier defined net cash flow to the implied equity held within the property. Determining the implied equity of a property requires the owner to have a good pulse on the current fair market value of their property. There are multiple ways to determine this value, an overview of which warrants an article on its own. Once a value has been determined, the outstanding mortgage balance and projected closing costs are deducted to arrive at implied net equity. The current net cash flow is expressed as a percentage of the implied net equity, resulting in the property’s ROE. This metric is critical for comparing the cash flow to what could be achieved if the property were to be sold and 1031 exchanged.
The Bottom Line
Since many investment properties have appreciated at a faster rate than the properties’ rents and net cash flow, it is not uncommon for investment properties to produce ROEs ranging from 2.5% – 3.5%. If cash flow is a priority to an owner, they may want to consider a 1031 Exchange replacement property option, like a Delaware Statutory Trust (DST), which offers the potential to improve current income. Delaware Statutory Trusts provide unique and customizable options to help meet your 1031 objectives.
As Chief Exchange Strategist, Austin leads the firm’s team of licensed 1031 Exchange advisors & analysts and provides consultation on tax liability, deferral strategies, legal entity structuring, co-ownership arrangements, 1031 replacement property options, and Delaware Statutory Trust investments.
Real Estate Transition Solutions is a consulting firm specializing in tax-deferred 1031 Exchange strategies and Delaware Statutory Trust investments. For over 26 years, we have helped investment property owners perform strategic 1031 Exchanges by developing and implementing well-planned, tax-efficient transition plans carefully designed to meet their objectives. Our team of licensed 1031 Exchange Advisors will guide you through the entire Exchange process and help you select 1031 replacement properties best suited to meet your goals. To learn more about Real Estate Transition Solutions, call 888-286-5395 or visit our website at www.re-transition.com/aoa.
IMPORTANT INFORMATION: The information herein has been prepared for educational purposes only and does not constitute an offer to purchase or sell securitized real estate investments. Such offers are only made through the sponsor’s Private Placement Memorandum (PPM), which is solely available to accredited investors and accredited entities. Case studies and examples are for illustrative purposes and not representative of future results. There are risks associated with investing in real estate properties, including, but not limited to, loss of entire investment principal, declining market values, tenant vacancies, and illiquidity. Because investor situations and objectives vary, this information is not intended to indicate suitability for any particular investor. This material is not to be interpreted as tax or legal advice. Please speak with your own tax and legal advisors for advice/guidance regarding your situation. DST 1031 properties are only available to accredited investors (generally described as having a net worth of over $1 million dollars exclusive of primary residence) and accredited entities only. If you are unsure if you are an accredited investor and/or an accredited entity, please verify with your CPA and Attorney. Securities offered through Aurora Securities, Inc. (ASI), member FINRA/SIPC. Advisory services offered through Secure Asset Management, LLC (SAM), a registered investment advisor. ASI and SAM are affiliated companies. Real Estate Transition Solutions (RETS) is independent of ASI and SAM.
Read more articles from the February 2022 edition of the AOA Magazine