Traditionally property return on investment is calculated by rental yield, especially when it is being compared to returns of other types of investments. However I believe it is a much more exact science, and can vary significantly depending on specific properties and on how the investor structured the deal when purchasing the property. A traditional yield of 5% can actually be 35% if the deal is right.
Let me start with a simple example. A two bedroom flat, bought with standard Buy-to-let 75% finance, at 5% interest only for £200,000 that is renting out for £10,000 per year. Traditional yield will be 5% (rent/value=10/200=5%). Under the way I calculate it, the rent less the mortgage interest divided by initial money in, therefore for this deal ((£10,000-£7,500)/ £50,000) so its 5%. The “real” return on investment is still the same.
But wait, what about capital gains, this is still a form of returns even though they may only be realised at a much later stage when selling and that will be liable for Capital Gains Tax. Well that is not strictly true, if the investor remortgages again after a year with similar terms, 75% of the capital gain can be realised. So if we make a very conservative and modest assumption in present gloomy market conditions of a 5% increase in value that is £10,000 and if we take 75%, and add it to the surplus cash from earlier that is a total of £10,000 return, effectively 20% return on the deposit paid. That is an amazing return, which I can’t see any other form of investment where the risks are so low and the investor has so much control over the asset.
There are certain things we have not considered like remortgage costs, legal and stamp duty, maintenance, and tenants. These will of course change calculations. Also the reason I simplify with a interest only mortgage, because if it was repayment that add to the capital or equity of the property so in effect cancels out the cost, although in realisation it will only be 75% realised when remortgaged.
Let’s be a bit more adventurous now, and add a few more clever changes to the model. We have to cap the borrowing at 75% LTV because that is the realistic maximum in the current lending condition. Let’s say the purchase price was 15% BMV (below market value) but the Mortgage was LTV, and the investor used a £10,000 personal loan at 10% compounded with capital and repayment due in two years, to part gather the deposit. So the initial investment in, is £10,000, the rest is the personal loan and the BMV saving. Assuming rent is steady; let’s look at the situation in 2 years time.
Property value in two years is now £220,500, so a refinance would raise an £15,375, less the loan that needs to be paid back (£12,100), plus £5,000 rent surplus which means £8,275 cash inflow, or 82.75% over two years on what was invested, so that is 35% return on capital invested per year.
There are incredible deals available; you can look around yourself, internet sites, auctions, personal contacts. If all else fails, contact us, info@PropVestment.com. You have to be clever with the way you invest, market condition are against us so we must beat the system and be innovative in our thinking.
Please take caution in tricky deals and do all your due diligence, the figures I use are fictional but are close to what is really possible.
How do you calculate your return on investment?