Return on Equity (ROE)

Return on equity is income divided by the owner's equity. For a financed rental, it compares cash flow after the mortgage payment with the down payment and closing costs. Cap rate measures the property; ROE measures the investor's share once a loan is in place.

On the example property, annual payments on a $375,000 loan at 7.25% over 30 years come to about $30,698. NOI of $28,892 does not cover it, so cash flow is about negative $1,806 and the return on the $125,000 of equity is below zero before any appreciation.

ROE rises above the cap rate only when the cap rate exceeds the loan's mortgage constant, about 8.19% here. When it does not, more leverage makes the return worse, not better. That comparison is the first thing to check before deciding how much to borrow.