Property Analysis – Part 1 – How it can save you thousands!Make Text Bigger
Whether you own one or one hundred properties you must monitor the performance of each property on a monthly and annual basis. Before you can do this though, you need to have a goal or target in mind as to the performance you wish to achieve with each property over a specified time period, whether 1 or 10 years.
Property analysis provides the information you need to understand what is really going on with your property and property portfolio. Otherwise, how will you know for future reference if a particular property purchase was a good or bad purchase?
So you purchased a property, but why did you purchase that property? Always ask yourself why am I buying this property before you purchase, not after. The first task is to set your desired gross rental yield, net rental income yield, return on cash in, and return on investment (ROI). If the financial indicators look bad on day one, chances are they will still look bad on day 300.
It all starts with the purchase. If you pay too much on purchase then the financial indicators will always look bad. Always do your sums and homework beforehand, and buy with built in equity on day one!
Once you own a property you must let it as quickly as possible. I shall not go into detail about how to let a property however it is suffice to say it’s important to minimise the initial void period. Always advertise in advance of the property being ready for occupation and ensure property photographs look professional, bright and appealing, making sure the property is looking presentable and at its best. Set the initial rent level conservatively to attract the most amount of attention. If you set the rent level too high and it stays empty for an extra two months, the lost rent may take up to two years to recover. Look to offer rental value, especially if the rental market is crowded or competitive. You can always aim to increase the rent after six months or a year. Lastly and most importantly, choose your tenants and managing agents wisely. For more on the subject on choosing tenants see this from mark Alexander.
Financial Property Indicators – Making the numbers work you
Let’s now look at some financial property indicators, there are many more but below are some of my favourites.
Gross Rental Yield = Gross Annual Rental Income / Property Cost
Use this indicator when purchasing. Expressed as a percentage it should ideally be targeted at 8% for a house and 10% for an apartment. Generally the rental yield will indicate whether you have bought into equity or not but don’t pass up on a property bargain just because the rental yield is low. Buying a property with built in equity and a lower rental yield is better than buying a property with high rental yield and no built in equity. Equity is something you can bank for the future whereas extra income is easily spent today.
When using this indicator on property already owned, use the current market value not the original purchase cost. The figure will be lower, but if this figure falls to 5% and the rent charged is correct it is then time to consider selling to buy higher yielding properties.
Net Rental Yield = Net Annual Rental Income / Current Property Value
Note: Net Annual Rental Income = Gross Annual Rental Income – Annual Property Costs – Annual Mortgage Costs
This financial indicator expressed as a percentage tells you the net return when measured against the current property value. Ideally you want to be looking at 3% as a target, as it will represent a good positive cash flow. Anything less than 2% could be cause for concern and deserves further investigation. If it’s less than 2% it will mean either the property the maintenance costs are too high, the borrowing level and/or the interest rate is too high or the rent is too low. It could even be a combination of any of these negative factors. Investigate and make corrections where possible but if nothing can be done then look to sell the property. Otherwise a small net return could turn into a negative net return when rates go up.
Gross Mortgage Coverage = Gross Monthly Rental Income / Monthly Mortgage Cost
Gross Mortgage Coverage = Gross Annual Rental Income / Annual Mortgage Cost
This is a quick indicator you can use to see if a prospective property purchase is an affordable proposition to buy and keep on an on-going basis. Expressed as a percentage it needs to be at least 200%, ideally 300%. If under 200% it will be hard for you to make a positive rental cash flow when all costs are taken into consideration.
Net Mortgage Coverage = Net Monthly Rental Income / Monthly Mortgage Cost
Net Mortgage Coverage = Net Annual Rental Income / Annual Mortgage Cost
This is another quick indicator you can use to see if a prospective property purchase is an affordable proposition to buy and keep on a long term basis. Expressed as a percentage it needs to be at least 50%, ideally 100%. If under 50% it will be harder to maintain a long term positive rental cash flow when all potential cost increases are taken into consideration.
Note: The reason I like to do this calculation this particular way is so that it shows you what percentage above the mortgage cost the property actual produces. So if the figure is 50%, it’s actually 150% or 1.5 times the mortgage cost if the mortgage cost does not form part of Net Rental Income calculation.
Also in the both mortgage coverage cases, don’t get faked out by a discounted mortgage rate. Use the mortgage rate applicable when the discount period ends. Think long term not short term.
Return on Cash in = Equity Gained / Cash in
Note: Equity Gained = Actual Property Value – Outstanding Mortgage – Cash in
Use this financial indicator to tell what level of “Instant Equity” you are gaining on day one of purchase. I ideally target this at 100% now. This means if I put £20,000 into a property purchase I want the total equity in the property to be £40,000. If the figure is below 50% I personally see little point in buying.
Who said property is all long term? Sure it was, but the rules of the game have changed since the credit crunch. Why plant sapling when you can plant a tree? Property can shine brighter than Gold if you buy right on day one!
To see an example of Return on Cash in, see Part 2 “The Snowball Effect”.
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