How do you measure return on your property investment

Untitled-1When it comes to property investment, how do you know if you are looking at a good investment?  How do you compare different properties with each other?  There are different ways of measuring returns on your property investment.  These include investor yield, cash on cash return and total return.

This first article focuses on yield.

Yield is the net annual income (rent) generated by the property (after all costs, but excluding bond repayments) in a selected period (usually a year) divided by the purchase price.

Yield is usually expressed as a percentage. The reason why bond repayments are not taken into account is because one needs to assess the inherent merits of the investment as if it was bought for cash.

The costs are usually made up of the following components:

1.        Rates and Taxes / Levies

If you own a house, you will pay property rates and taxes. If you’ve purchased your property for investment purposes, you’ll recover the utility costs (e.g. water and lights) from your tenants, but the landlord typically still has to pay for property rates, which is an amount calculated on the market value of a property (land and buildings) which goes towards paying for streetlights, keeping your immediate vicinity clean from rubbish, cutting the grass on municipal grounds, and so on.  As an aside, make sure that your lease clearly specifies who is responsible for which costs. For example, if you want your tenant to pay for refuse removal (or for property rates, although this is not the norm), this should be specified in the lease.

If you are renting out a flat or a house/townhouse in a gated community, you will usually pay municipal rates and taxes, as well as a levy to the Body Corporate/Home Owner’s Association. The levy usually provides for aspects such as security, and maintenance for the building/estate. Tenants would once again pay for utility usage (in some complexes, water is included in the levy).

2.        Letting Fees

If you have decided on appointing a letting agent to rent your property out for you, you will normally pay the agent a commission based on the rental, and “recoveries” (e.g. water and lights) they collect for you.  Thus if your rental is R5 000 and their letting commission is 10% plus VAT, you will have to pay R500 plus VAT per month as an extra cost (as well as 10% plus VAT on the “recoveries”).  If the flat is not rented out, the agent is not paid. Most agents charge a “finder’s fee” as well (typically the equivalent of one month’s rent).

3.       Maintenance Fees

As a landlord you will see that as time goes on, some items in your investment will start to need fixing, such as the roof, the ceilings, geysers, etc.  A good idea is to put away a certain amount per month that goes towards a fund which you can call on as these items start to deteriorate.  If you do not put this amount away, you could potentially have to fork out a large amount of money that you have not budgeted for.

4.        Other

There are a number of other costs you may be liable for depending on the type of rental agreement you have with your tenant i.e. garden cleaning services, pool maintenance, etc.

Initial yield refers to net income in the first year.  Assuming a purchase price of R600 000, a monthly income of R4 500 and costs of R1 000 (giving a net income of R42 000 a year), the initial yield is 7%.

The above describes how yield is typically calculated and how it is reported in the general press. However, yield can be calculated in different ways. For example, gross yields are often used in overseas publications and do not take operating costs into account.

For a yield calculation to be truly accurate it should be refined to take all costs into account, such as transaction costs related to the purchase (legal fees, transfer duties etc.) as well as vacancy factors. When calculating yield it is important to keep in mind that the yield will only be as accurate as the assumptions made.

Look out for our next article, which will cover additional ways of measuring returns of investment property.