Understanding Return on Equity (ROE) in Real Estate
What is ROE and Why Does It Matter for Rental Property Owners?
Return on Equity (ROE) is a key metric that helps rental property owners measure how effectively their equity is being used to generate returns. However, instead of using simple equity (market value minus mortgage balance), a more accurate approach considers Net Equity—the amount you would have after selling, factoring in realtor fees, legal costs, capital gains taxes, and other selling expenses. This provides a true measure of how much capital is available for reinvestment.
How to Calculate ROE for Your Rental Property
To calculate ROE, use the following formula: ROE = (Net Income / Net Equity After Sale) x 100 Net income includes rental income minus operating expenses, property taxes, and mortgage interest. Net equity is determined by taking the market value, subtracting the mortgage balance, and then further subtracting all selling costs.
Interpreting ROE: What’s a Good Percentage?
A strong ROE varies based on market conditions, property type, and investment goals. A low ROE might indicate that your equity is underperforming and could be better utilized elsewhere.
Option 1 – Selling Your Rental Property and Reinvesting
How to Calculate Capital Gains Tax in Canada
Capital gains tax applies to 50% of the profit made from selling a property. Understanding these tax implications helps determine net proceeds.
Net Proceeds: Understanding Selling Costs and Taxes
Selling costs include:
- Realtor commissions
- Legal fees
- Mortgage discharge penalties
- Capital gains tax
Where to Invest Proceeds for Maximum Returns?
Options include:
- Stocks or REITs
- Buying another rental property
- Private lending or alternative investments
Comparing ROE: Keeping vs. Selling & Reinvesting
Once you have calculated net proceeds from a sale, compare potential investment returns. If reinvesting the proceeds generates a higher ROE than keeping the rental, selling may be the better option.
Option 2 – Keeping Your Rental Property ‘As Is’
How to Evaluate Your Property’s Current Financial Performance
Assess rental income, operating expenses, market trends, and potential for appreciation. Stability and strong rental demand are key indicators for maintaining ownership.
Net Income Calculation: What Goes Into the Numbers?
- Gross rental income
- Property management fees
- Repairs and maintenance
- Property taxes
- Mortgage interest
- Insurance and other operating costs
ROE Calculation Example for a Rental Property
For a property valued at $600,000 with a mortgage balance of $300,000 and an annual net income of $18,000:
- Estimated selling costs (legal fees, realtor commissions, taxes) = $40,000
- Net equity after sale = $260,000
- ROE = ($18,000 / $260,000) x 100 = 6.9% If ROE is low, it may be time to explore other options.
Option 3 – Refinancing or Re-Amortizing Your Mortgage
What’s the Difference Between Refinancing and Re-Amortization?
- Refinancing replaces the current mortgage with a new one, often at a different interest rate and term.
- Re-amortization adjusts the mortgage payment schedule, typically extending or shortening the repayment period to change monthly cash flow.
How Refinancing Can Impact Your Cash Flow and ROE
Refinancing can lower interest rates, unlock home equity, and improve cash flow, increasing overall ROE.
Tax Deductibility of Mortgage Interest in Canada
Mortgage interest on rental properties is tax-deductible, reducing taxable income and improving investment returns.
ROE Before and After Refinancing: A Case Study
By refinancing to extract equity and reinvest, an investor can shift underperforming equity into higher-yield assets, improving overall returns.
Key Tax Considerations for Rental Property Owners
How Rental Income is Taxed in Canada
Rental income is taxed as personal income, subject to applicable tax brackets.
Common Tax Deductions for Landlords
- Mortgage interest
- Property taxes
- Depreciation (Capital Cost Allowance)
- Repairs and maintenance
Understanding Capital Gains Tax on Real Estate
Capital gains taxes apply when selling a property, reducing net proceeds and must be factored into financial planning.
Additional Factors to Consider Before Making a Decision
Real Estate Market Trends & Timing Your Move
Evaluate interest rates, housing supply, and demand trends to determine if refinancing or selling is strategically sound.
Long-Term Wealth Strategy: Where Does Your Property Fit?
Consider whether your property aligns with your broader financial goals and retirement plans.
Why Professional Advice is Essential Before Refinancing or Selling
Mortgage brokers, tax professionals, and financial advisors can provide insights to optimize your decision.
Conclusion – Making the Best Choice for Your Investment
Recap of Key Considerations
- ROE should be calculated based on Net Equity After Sale, not just simple equity.
- Selling first helps determine this net equity, which impacts refinancing and holding decisions.
- Tax implications and market trends must be considered before making a decision.
How to Use ROE to Make a Data-Driven Decision
Use ROE calculations to compare the financial impact of each option and determine the best move.
Rental Analysis Calculator
If you’d like to see real numbers for your property and don’t want to waste time running the math yourself, I’ve built a calculator that gives you a report with all of the math broken down for you.
Fill out this form, I’ll crunch the numbers and send you a personalized report for your property.