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— Multifamily Properties Quarterly — May 2016
P
rices in the Denver multifami-
ly market continue to rise and
seem to be at all-time highs.
This has caused many inves-
tors to scratch their heads,
trying to figure out what they need
to do in order to get the best return.
As a result of Denver’s recent eco-
nomic success and highest number
of purchases in the last seven years,
we have seen a great deal of value
appreciation and cash flow generated
for investors.
When I sit down with property
owners, a similar discussion always
arises – what is the real return on
their asset? There are two basic cal-
culations that will gauge how well
investors are doing on a return basis:
return on investment and return
on equity. ROI is the more popular
choice; however, I argue that the less-
discussed term of ROE should be paid
more attention to in today’s market.
ROI is defined as the gain or loss
generated on an asset relative to the
amount of money invested. ROI usu-
ally is expressed as a percentage and
typically is used for personal financial
decisions in order to analyze a prop-
erty’s profitability. This calculation
is what many investors use when
comparing real estate investments to
make the best decision on where to
place their equity. This is a great way
to look at purchasing a property and
an indication of what you can expect
from a return over time.
One pitfall with this calculation is
it does not take into account chang-
ing market conditions. In worsening
market conditions, the percentage
an investor will calculate as ROI
will decrease. In
improving market
conditions, the ROI
should increase in
most cases. The bot-
tom-line question to
ask ourselves with
the ROI calculation
is, “What is the real
return the investor
is making on his
equity?”
The less-dis-
cussed term, ROE,
is not as commonly
used in the real
estate investment world, in part,
because we have not seen such dra-
matic increases in real estate values
for some time. In the past, many
owners were worried about their
decreasing returns and value. The
conversation rarely turned to, “What
is my return on equity?” Many own-
ers now are sitting on a large sum of
equity that is not being used to its
fullest potential.
ROE is calculated in the following
manner: a percentage measuring
the return received on a real estate
investment property as related to
the equity in the property. Addition-
ally, ROE can be calculated based on
the projected value of the property
less the mortgage balance. These
calculations would give you the cur-
rent equity you have in the property
adjusted by any increase in value and
pay down of the mortgage. This value
should be something that an investor
would look at during a hold period.
Many times the ROE percentage rate
is much lower than an owner would
expect or want, for that matter. Let’s
take a look at an example below.
An investor sells his Capitol Hill
multifamily asset for $3 million today
at a 5.5 percent capitalization rate.
The investor originally purchased
the property in 2010 for $1 million at
an interest rate of 4.5 percent over
a 30-year amortization and has an
annual debt service of $45,600. At the
time of the sale, the net operating
income was $165,000 and the inves-
tor’s cash flow is $119,400. Let’s pre-
sume the asset has never been refi-
nanced and the debt has been paid
down to $655,000. The equity in the
property is now $2,345,000. The ROE
on estimated value in today’s market
is 5.09 percent (cash flow/equity).
That same investor takes his equity
of $2,345,000 and purchases a new
multifamily asset in the suburbs of
Denver. The new property is pur-
chased for $9,380,000 (fully leverage
with current equity) at a 7 percent
capitalization rate. The investor
places his equity from the Capitol Hill
property as a down payment and has
a debt of $7,035,000 at an interest rate
of 3.75 percent over 30 years. The NOI
of this property is valued at $656,600,
and the cash flow minus the debt
Adam Riddle
Senior vice
president, Unique
Properties Inc.,
Denver
Investment Market
Graphic courtesy Unique Properties Inc.
