Return on Equity (ROE)

Return on equity measures income relative to the owner's own capital. For a financed rental, it is cash flow after debt service divided by the owner's equity. Unlike NOI, it depends heavily on the loan, and it can be well above or below the cap rate.

Put 40% down on the default house and the $200,000 of equity earns about $4,330 a year after a $24,558 loan payment, roughly 2.2%. That is well under the 5.78% cap rate, because the loan costs more than the property yields.

Later in a hold, ROE is often measured on current equity: market value less the loan balance. As NOI and value grow, equity grows faster than cash flow, and ROE tends to fall. Some owners refinance or sell at that point to put the equity to work elsewhere.