How do you measure return on your property investment?

Article 2 in the series

Different ways of measuring return - Article 2

How do you measure return on your property investment?

There are different ways of measuring return, and our objective through this article series is to demonstrate how each of them can become applicable, depending on the context.

Recap on Article 1
Article 1 focused on Yield.  If you recall, Yield is the net annual income (rent) generated by the property (after all the costs, but excluding bond repayments) in a selected period (usually a year), divided by the purchase price.  Yield is usually expressed as a percentage.  We highlighted that the bond repayments are not included in this calculation.

Total return and cash on cash return are additional methods to calculate return on investment property, and these form the subject of this article.

Total return

You may have noticed that Yield neglects to include an important feature of the investment, namely capital growth, which is the growth in the value of property over time. If you wish to measure total return, you will need to look at both yield (income return) and capital growth.

Total return is thus the initial yield on a property in a selected year, plus the expected increase in the value of the property, expressed as a percentage (or the actual yield and capital growth over an historic period, for example the last year, if you are measuring historic returns).   Therefore, if the yield is 10% and the property value is expected to grow 5% in the coming year, the total return will be 15%.

Cash on cash return

The concept of initial yield is sometimes criticised as being over-simplistic.  However, initial yield has a place as a simple, quick calculation to help you to compare the return you might expect from investment properties.  The main thrust of the criticism is that initial yield does not take account of the “cash on cash” return.  This refers to the return on the cash put into the deal.

It may be helpful to use an example to highlight cash on cash return.  For example, you purchase a property for R800 000, pay a R80 000 deposit, anticipate gross monthly rental income of R10 000, and operating costs of R2 000 (your net monthly income is thus R8 000).

Therefore, your annual net income is R8 000 x 12 = R96 000.  Your annual bond repayments (assuming a 90% bond, at a 8.5% interest rate over 20 years) will be R74 976 (R6 248 per month).

To calculate cash on cash return, you should use the following equation:

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It is important to note that cash on cash return will change as your financing options change, whereas the investor yield will not be affected by finance at all.