How do you measure return on your property investment?

Article 3 in the series

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How do you measure return on your property investment?

Recap

Recapping on our previous articles in the series, Yield is probably the simplest calculation to use for residential property investment, and is useful as a quick guideline to the anticipated income return on a property. 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, which was highlighted in our second article, includes capital growth in its calculations.  The anticipated capital growth percentage for the coming year (or a historical period if you are doing this calculation retrospectively) is added to the Yield percentage.  For example, if the anticipated capital growth on the property is 5% and the yield is 10%, the total return is thus 15%.

Cash on cash return includes the cost of bond repayments and can be calculated by determining the annual net income less the annual bond repayments, divided by the cash injected into the deal, and expressed as a percentage.

“Actual” Net Yield

This article introduces the concept of “Actual” Net Yield, which attempts to paint a realistic picture of the returns that can be anticipated from an investment property (the term “actual” net yield is not an industry term, and is simply used in this article to describe the concept).

The premise of “Actual” Net Yield is that all costs, such as transfer and renovation costs, need to be taken into account when calculating Yields.  Additionally, it is prudent to acknowledge that the property may not be occupied for the full 12 months of the year.  As a result, vacancies should be built into the calculation.

The calculation thus becomes the following:

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In order to perform this calculation, you will need to know the expected transfer and bond registration costs for the investment property that you may be thinking of purchasing. A bond and transfer cost calculator can be found at ooba.co.za

Example calculation: Let’s assume that we purchase a property for R1.6 million, and that the property will deliver a rental of R14 000 per month.  Our costs will be R2 000 a month.  This gives a gross income of R168 000, less our R24 000 in costs, and will thus deliver a net income of R144 000 per annum.  But, we’re assuming that the property will be vacant for one month in the year. The expected initial renovations will cost R100 000. For the purposes of determining the bond registration costs, we’re assuming a 90% bond.

The “Actual” Net Yield is thus:

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In this example, the “Actual” Net Yield will be 7.2%.

It is important to note that we subtract one full month’s rental, rather than the net rental, as you still need to pay your levies and any other applicable costs when the property is vacant.

It is important never to base an investment decision solely on one indicator.  You need to balance return calculations with gut-feel about the investment property that you are purchasing.  This is best developed by viewing multiple properties in numerous areas, and by talking to estate agents and other property investors.

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