What Is Your Equity Earning Today?

Ask an owner what he paid for his building and he answers to the dollar. Ask what it is worth today and he is rarely off by much. Ask what his equity is earning at today's value, and the room goes quiet.

It is the most useful number in this whole library, and almost nobody knows theirs.

The arithmetic

Say you bought a property years ago for $1,000,000, free and clear. It produced $60,000 of net operating income (the rent left over after operating expenses), so it earned 6 percent on your money: $60,000 divided by $1,000,000. A good buy.

Today the property is worth $3,000,000, and the income has grown to $75,000. The instinct is to feel twice as good: the building is worth three times what you paid, and the checks are bigger. But run the number the way a buyer would run it. $75,000 divided by $3,000,000 is 2.5 percent. That is what your equity earns at today's value.

You are your own buyer

Here is the way to think about it: every year you keep the property, you are choosing it over everything else your equity could own. You are, in effect, buying it again each year at today's price. Would you write a $3,000,000 check today for a $75,000 income stream? A buyer would call that a 2.5 cap (the year's net operating income divided by the price, the yardstick income property is compared with) and most would keep looking.

Why the number hides

Nothing about a deed reminds you to re-run the arithmetic. The purchase price is carved into memory and the tax bill; today's value only shows up when an appraiser or a broker visits. And rising value feels like performance, even while it quietly dilutes the return on every dollar sitting inside the property.

This is not an argument that you bought badly. You bought well. The 6 percent became 2.5 percent partly because the property performed. Trapped equity is usually the reward for a good decision, which is exactly why it is so easy to leave alone.

What owners do once they see it

We watched an owner make this discovery recently. He had no interest in selling until he ran the return his equity was actually earning; the number did what no argument could, and a reluctant seller became something more interesting: a buyer, with his equity, of the benefits he actually wanted.

That is the pattern. Once the number is real, the question changes from "why would I ever sell?" to "what should this equity be doing for me?" And sometimes the honest answer is: exactly what it is doing now. There are good reasons to hold at a modest return. You may prize the safety, the tenant may be irreplaceable, the land may be the legacy itself. The point is not that every owner should move. The point is to decide with the number in hand, not without it.

Run yours

1. Take this year's net operating income: rent collected, minus operating expenses, before any loan payment.
2. Take an honest estimate of today's market value. A broker's opinion or recent comparable sales will do to start.
3. Divide the first by the second. That percentage is what your equity earns today.

If you carry a loan, run the sharper version: income after the loan payments, divided by today's value minus the loan balance. That is the return on the equity itself, and it is usually the more sobering number.

If the result surprises you, that is worth a conversation. Use My Equity shows the forms the next step can take, The Stairway of Benefits is the ladder for deciding what you would rather own, and the first conversation with us is complimentary.