Home Equity

Home equity is a property's market value minus the balance of loans secured by it. It is the owner's stake. Cash on cash return measures income against the cash first invested, not against current equity, which grows over time.

On day one, the default property has $125,000 of equity: $500,000 value less the $375,000 loan. After five years of payments the balance is about $353,900. At an unchanged value, equity is about $146,100, and any appreciation adds to that.

As equity rises, the same cash flow becomes a smaller return on the money tied up in the property. That is the gap between cash on cash return and return on equity. Investors watch it to decide when to refinance, sell or move equity into another deal.

Further reading: Home Equity on Wikipedia.