How to calculate return on property investment
How to calculate return on property investment: starting simple…
Let’s start with a simple example to illustrate the basic idea of how to calculate return on property investment.
In this scenario, imagine you have spent 140k on a property (including mortgage fees, stamp duty, surveyors’ costs, estate agent fees, etc.), renovated it over a number of years and sold it on for 200k cash.
To work out the ROI in this case is pretty straightforward. You divide the capital gain you’ve made on the property (60k) by the initial purchase price (140k) and multiply by 100 to get a percentage.
60/140 = 0.429 x 100 = 42.9%
So, your return on your initial investment is about 43%.
Things get a little bit more complicated when you start looking at properties purchased with a mortgage. Since this covers most people starting out in property investment, we will move on to this next.
How to calculate return on property investment when you have a mortgage
To simplify things, it is useful to swap the generic term ROI for a more specific one: return on cash invested (ROCI).
For the next example, we will stick with the same property, again bought for capital growth. But in this case, imagine that it was bought with a mortgage. This specific mortgage deal requires the buyer to stump up a 35k deposit.
Using ROCI as a metric, we can ignore the mortgage, because the buyer has not had to use any of their own money.
ROCI is therefore 60/35 = 1.714 x 100 = 171.4%
Now, this example is clearly flawed, because it doesn’t take into account ongoing mortgage interest payments, maintenance costs, agents’ fees, etc. However, it does demonstrate how property investment starts to look a lot more appealing when you focus on cash returns.
Next, lets look at how to calculate return on property investment if you intend to let out the property.
When you step into the rental market, you will soon come across the term ‘yield’.
In a nutshell, yield is the annual return on investment you can expect from rental income.
To calculate gross yield, you simply divide your annual rental income by the total cost of your property purchase.
If you are charging £750 per month (9k per year) for rent, that would be:
9/140 = 0.064 x 100 = 6.4% gross yield
A similar calculation could be made using the current property value. This is known as the property’s cap rate.
Either way, yield or cap rate are best used as comparison tools. They aren’t very useful for calculating specific returns.
For a more accurate figure, you should use net yield. The concept is the same, but you focus on actual costs by deducting your operational expenses (mortgage interest, agents’ fees, insurance, estimated repairs, etc.).
Say this adds up to £1,500 per year, your calculation would be:
7.5/140 = 0.054 x 100 = 5.4% net yield
Unless you have bought the property in cash, your next step should be to substitute the property’s purchase price for the amount of cash you invested. This will give you your expected return.
Using the example of a 35k deposit, ROCI = 7.5/35 = 0.214 x 100 = 21.4%
What about equity?
To maximise returns, most landlords use buy-to-let mortgages to finance rental properties. Since they are only covering interest payments, the initial loan amount is irrelevant to return calculations.
But if you have a capital repayment mortgage, you will (hopefully) be adding equity in the property every month. In this case, your returns calculation should include the capital repayments made as shown on your loan amortisation statements.
As mortgages are structured to progressively pay off more of the capital over time, your returns will increase.
If this article has piqued your attention, we invite you to attend one of our upcoming FREE property seminars. We will be happy to answer any questions you have about calculating returns or any other aspect of property investing.