Return on equity (ROE)
Return on equity (ROE) indicates how much you profit from an investment.
The calculation of return on equity is pretty simple:
Return on equity (in %) = (annual net income/equity) x 100.
The annual net income is your rental income minus any interest costs for your construction financing.
The best way to make this clear is with an example.
Purchase price: 150,000 €
Incidental costs (10%): 15,000 €
Total acquisition costs: 165,000 €
Rental income per year: 7,000 €
The model calculations:
You pay the acquisition costs (165,000 €) completely with your own capital:
ROE: (7,000 € / 165,000 €) x 100 = 4.24%
You finance 100% of the purchase price and pay only the additional costs yourself. The interest rate is 2% per year. That makes 3,000 € interest costs per year:
ROE: ((7,000 € - 3,000 €) / 15,000 €) x 100 = 26.67%
As you can see, it's worth it. This phenomenon is what we call the leverage effect. If you've already saved money, it might pay off to not put it all into one loan but to use the money to buy and finance another property instead.