Return on Equity (ROE)

Return on equity is a company's net income divided by shareholders' equity. It is the corporate analogue of cash on cash return: both measure the return on the owners' money after paying the cost of debt, and both rise or fall with leverage depending on whether the asset earns more than the debt costs.

The DuPont decomposition of ROE separates operating return from the effect of leverage, and the same logic applies to a rental. Return on the asset is the cap rate. Return on equity is cash on cash. The difference is the spread between the cap rate and the cost of debt, multiplied by how much debt is used.

For a property investor, equity also changes over time. As the loan pays down and the property appreciates, equity grows while cash flow may not, so the return on current equity falls even when cash on cash on the original investment looks fine. That is the argument for measuring return on current equity periodically and refinancing or selling when it drops below what the cash could earn elsewhere.

Further reading: Return on Equity (ROE) on Wikipedia.