ROI calculation, which do you use?

by Readers Question

11:58 AM, 24th February 2014
About 7 years ago

ROI calculation, which do you use?

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ROI calculation, which do you use?

I’m preparing some spreadsheets to identify which local properties might offer good returns on investment but I’m getting conflicting advice on how to calculate that return. ROI calculation

I’ve been told that 8% is the minimum ROI, 10% is good, 12%+ great. However the calculations i’m getting from existing BTL investors, books and the interweb are conflicting. Can you help?

The basic formula is ((income/investment) x 100). But how do you define the income – is it net income, gross income? And how can we define investment – is it the purchase price, the deposit?

Thanks

Frank

 



Comments

Mark Alexander

12:03 PM, 24th February 2014
About 7 years ago

Hi Frank

There are dozens of different calculations you could use and there are thousands of opinions out there as to what is best, target ROI etc.

The reason we don't all come up with the same answers are the very same reasons we don't all drive the same car or go on the same holidays, i.e. budget, attitude to risk, availability of time, location, family commitments and above all personal preferences.

However, we have developed two tools to help you to crunch the numbers and research your own comparables in order to arrive at your own conclusions.

1) Landlords Calculator - http://www.property118.com/calculating-rental-yields-and-returns/

2) Property Research Tool - http://www.property118.com/property-search-tool/

I hope that helps 🙂
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Andrew H

12:41 PM, 24th February 2014
About 7 years ago

Hi Frank.

Yields are like APR and are used in the same way - to quickly compare and evaluate different opportunities. The number that you want to focus on is your return on capital employed. In other words, for every pound that you spend, how much are you getting back after ALL associated costs have been deducted?

Some One

13:03 PM, 24th February 2014
About 7 years ago

Personally I just use the calculation of a yield percentage as a quick initial rule of thumb check, which, for me, tends to be gross yield needs to be above 6% before I'll look into a place in any more detail (By gross yield I mean gross annual rent/purchase price).

Such a figure will vary according to what you're doing, eg: if its an HMO I'd want a higher figure (although I don't do any so I don't know what figure would keep me happy), in some places you may accept a lower rent:price yield on the assumption that capital appreciation will be higher.

You can do all sorts of other calculations, net income vs purchase price, net income vs initial investment, etc. But, once you start doing this the accuracy can go all over the shop - what void level do you estimate, how much maintenance, are you including capital appreciation - if so how do you estimate that?

Michael Barnes

1:32 AM, 25th February 2014
About 7 years ago

I've had this discussion with my financial advisor (FA), when comparing returns on lettings against returns if I invested money else where.

I used the amount of capital I had in the business; FA said it should be value of the properties.

In my case I have no btl mortgage; all finance raised against my home. That means that all the money invested in btl could be invest ed elsewhere. With btl mortgage, the mortgage funds would not be available for investment elsewhere, they would need to be repaid when property is sold.

Based in the above, I would say that Investment is either
a) value of property, if no btl mortgage, or
b) value of property less btl mortgage
But also could reasonably be taken as "your money in the business", i.e value of property less all borrowings used to finance.

Income should be gross income less expenses, but probably not less tax. That allows resonable comparison with other investments.

However, if you are using borrowings that are not tied to the let property, then for comparison with alternate investments you should probably exclude interest payments from the expenses.

For historical calculations you may include change in property value in the income calculation (noting that value could gio down), but it is not easy to do this for future projections, and anything you allow for this is no more than a guess.

In summary, I would say that what you class as investment and Income depends on what you are doing the calculations for and your specific circumstances 😉

Mark Alexander

19:19 PM, 25th February 2014
About 7 years ago

Hi Frank

I have another calculation for you to consider when using our Landlords Calculator >>> http://www.property118.com/calculating-rental-yields-and-returns/

Given that the BoE agree that the natural interest rate is 5% and the CML agree that the natural landing margin for BTL business is 3% then your breakeven figure on any deal should be at least 8%.

If you can't get you deals to stack up at that level, try swapping some of your traditional interest bearing mortgage finance for equity finance - see http://www.property118.com/equity-finance-for-buy-to-let-landlords/44713/

To calculate your returns on this basis using our landlords calculator try reducing the mortgage debt figure by 20% of the property value and also reduce the property value by 20% too. You will see that this gives you a completely different set of figures. I do recommend you also weigh up the pro's and cons of equity finance too though and there is a superb analysis of this via the discussion article I've linked you to above.
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Frank Coles

10:45 AM, 26th February 2014
About 7 years ago

Reply to the comment left by "MdeB " at "25/02/2014 - 01:32":

Hi,

Thanks all for your responses to my original question. Clearly no one has a definitive answer on this and mostly we are all working on received and possibly faulty wisdom.

Here's how I structured my yield spreadsheet in Excel. Each potential property has a separate entry that returns values for:

1. Gross yield = (Monthly rent * 12) / Cost of property
2. Net rental yield = ((Monthly rent - running costs) * 12) / (Cost of property + purchase costs)
3. ROI 1 = (net income/investment (deposit+purchase costs) x 100)
4. ROI 2 = (gross income/investment (purchase price + purchase costs) x 100)

Each answer is then formatted to display a red danger colour for low yields and a graded green for a go (research or buy) decision.

Very useful as a psychological tool as well. Took a day to train myself that red means walk away, not see if I can make it work.

In one day I've found more go projects than I knew were there before and have cut down the research time enormously. I also won't have to stretch myself thin or overfinance.

Cheers, F

Mark Alexander

15:33 PM, 26th February 2014
About 7 years ago

Reply to the comment left by "Frank Coles" at "26/02/2014 - 10:45":

Hi Frank.

I follow your calculation but not your logic - not completely anyway.

There are three ways to make money, specially if you have reserves or cashflow to prop up deals.

1) An ROI which makes sense now and on a stress tested interest rate basis (and hopefully some capital appreciation in the long term)

2) Trading, e.g. adding value to a property and flipping - possible no ROI whatsoever until sold, e.g. refurb to sell or full blown development.

3) Speculation, e.g. holding a property which makes very little profit or may even need to be cashflow subsidised in the hope of capital gains.
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Frank Coles

16:11 PM, 26th February 2014
About 7 years ago

Reply to the comment left by "Mark Alexander" at "26/02/2014 - 15:33":

Hi Mark,

Sorry, left out the obvious. The yields/roi in this case are for BTL properties mainly. If they all add up then it's a good project as per your (1).

Running the numbers in this way will also give you your overheads while flipping (2), these do affect your ROI, and it identifies your negative cashflow for (3).

Basically I needed to counter the reams of conflicting advice online and from people, in the last day I've had 5% offered as a good yield (but no indication of gross or net), 8% net min from a developer, and 20% min from a random.

As any BTLs are investments over time a little more research upfront to source high yield income properties in good rental areas seems time well-spent as those little % add up.

Property trades: buy low/sell high are something I'm interested in and learning more about. Speculation is something we are already doing but finding it harder to find the properties now tbh.

Where did you get that BofE natural rate info from btw? I'd love to see more on that.

Cheers. F

Mark Alexander

16:42 PM, 26th February 2014
About 7 years ago

Reply to the comment left by "Frank Coles" at "26/02/2014 - 16:11":

Hi Frank

See >>> http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2013/qb130306.pdf

My business partner, Neil Patterson and I, both have very close links at the BoE. Neil attends all of the local briefings, I used to but don't have the time anymore but I do get along to one or two every year and read all of Neil's summary articles posted here. I give him a hard time about them being boring but (and never let on to him I've said this) he really does know what he's talking about. See his latest article here >>> http://www.property118.com/bank-of-england-quarterly-inflation-report-summary/63723/
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