Essential Property Investment Calculations: Your Key to Distinguishing Between a Good and Bad Investment

When diving into the world of property investment, understanding the numbers game is crucial to insure you make good investments and maximise your returns. It's not just about picking a property that looks good; it's about making sure the maths adds up to a profitable investment.

In this guide, we'll walk through the essential property investment calculations you need to master to differentiate a good investment from a bad one. Armed with these calculations, you'll be well on your way to making informed decisions that could lead to significant returns and create that profit that you seek. So, go grab a calculator, and let's get started!

Gross Yield

If you are planning on investing in property to create income streams from rent then gross yield is your starting point in the world of property investment calculations. It gives you a rough overview of the return on your investment before expenses are taken into account. To calculate gross yield, you divide the annual rental income by the property purchase price (or current market value) and then multiply by 100 to get a percentage.

Example: If you buy a property for £200,000 and rent it out for £1,000 per month (£12,000 per year), your gross yield would be:

Gross Yield = (£12,000 / £200,000) × 100 = 6%

A useful comparison is to look at the best fixed saving rate that you can get from your bank account. Ideally if you are looking to maximise returns you will want this number to be higher than what you could achieve by leaving the money in a savings account.

A higher percentage indicates a potentially more profitable investment, but remember, this is just the tip of the iceberg.

Net Yield

Net yield takes the calculation a step further by considering the operating expenses of owning the property, including maintenance costs, management fees, and insurance. Subtract these annual expenses from your annual rental income before dividing by the purchase price.

Example: If your annual expenses are £2,000, your net rental income is £10,000 (£12,000 - £2,000). Using the same property purchase price (£200,000), your net yield would be:

Net Yield = (£10,000 / £200,000) × 100 = 5%

This gives you a more accurate picture of your investment's profitability after expenses. Its easy to forget about the costs of owning an investment property and many people fall into the trap of just looking at the gross yield.

Capital Growth Rate

Capital growth rate measures how much the value of your property investment has increased or decreased over time. To calculate it, subtract the purchase price from the current value, divide by the purchase price, and then divide by the number of years you've owned the property. This shows what the property has grown on average for each year you have owned it.

Example: If you bought a property for £200,000 and it's now worth £250,000 after five years, your capital growth rate would be:

Change in Value = £250,000 − £200,000 = £50,000 Increase

Annual Rate = £50,000 / 5 years = £10,000 per Year

Growth Rate = £10,000 / £200,000 = 5% Capital Growth Rate

This calculation helps you understand the appreciation of your property over time. A higher % shows a higher return on the invested capital. This doesn't take into account any alterations you may have performed on the property and could give you an inflated view of the investment. For example if you had invested £50,000 on renovation then the asset is worth more but you have also spent the same amount so your actual return is zero.

Return on Investment (ROI)

ROI is a critical metric that measures the efficiency of your investment. It considers both the capital gain and the net income generated by the property. To calculate ROI, add the net income to the increase in property value, divide by the initial investment, and multiply by 100.

Example: Using the previous examples, if your property appreciated by £50,000 and generated £50,000 in net income over five years, your ROI would be:

Returns = £50,000 + £50,000 = £100,000

Return on Investment = (£100,000 / £200,000) * 100 = 50%

This figure shows the total return on your investment, combining income and capital growth. Again its worth noting this does not take into account renovation costs unless you have factored that into your net income amount.

Loan to Value (LTV) Ratio

The LTV ratio is crucial if you're financing your property investment with a mortgage. It represents the percentage of the property's value that's financed by the loan. Lenders use it to assess the risk of the loan. To calculate LTV, divide the mortgage amount by the appraised property value and multiply by 100.

Example: If you have a £150,000 mortgage on a £200,000 property, your LTV ratio would be:

LTV Ratio = (£150,000 / £200,000) × 100 = 75%

A lower LTV is generally more favourable and may qualify you for better loan terms. Banks are willing to offer lower interest rates on lower LTV's due to the higher value in the property.

Conclusion

Mastering these essential property investment calculations will equip you with the knowledge to assess potential investments more effectively. Remember, while these calculations provide a solid foundation, it's also important to consider other factors such as location, market trends, and your long-term investment strategy. By combining analytical skills with a strategic approach, you'll enhance your ability to distinguish between a potentially good and bad property investment.

Happy investing, and remember, the numbers never lie, but they do need to be interpreted wisely! Its up to you to set your target metrics and appraise your current and future investments against these to be able to appraise your returns.

Understanding these calculations and applying them to your investment strategy can significantly impact your success as a property investor. So, take your time, practice these calculations, and always stay informed about the market to make the most out of your property investments.