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THE KEY PROFITABILITY MEASURES YOU NEED TO KNOW
Here are the key profitability measures that you need to know when you are investing in property:
ROI = (Net Profit / Money Left In) * 100
Here's how you can break down the calculation:
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Determine the amount of money left in the deal: Add up all the costs associated with purchasing the property. This includes the purchase price, SDLT, legal fees, refurb costs, and any other expenses directly related to the acquisition minus any money returned to you during the refinance process.
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Calculate the Net Profit: Calculate the net profit generated by the property annually. To calculate the net profit, subtract all the property-related expenses (such as mortgage payments, insurance, maintenance costs, property management fees, and utilities) from the total income generated by the property (rental income).
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Apply the Formula: Divide the net profit by the total investment and multiply the result by 100 to get the ROI percentage.
For example, let's say you purchased a property for £200,000 and incurred £10,000 in fees (SDLT, legals, etc) and spent £40,000 in renovations, resulting in a total investment of £250,000.
You refinanced the property at £300,000 and took out a 75% LTV mortgage meaning the lender gave you £225,000. The money left in the deal would therefore be £250,000 minus £225,000 which is £25,000.
Over the course of a year, the property generates £20,000 in rental income, and after deducting expenses (mortgage payments, bills, maintenance, etc) the net profit is £10,000.
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ROI = (10,000 / 25,000) * 100 = 40%
In this example, the ROI on the property purchase is 40%. ROI is typically used as a measure for projects you are holding or refinance.
ROCE = (Net Profit / Capital Employed) * 100
Here's how you can break down the calculation:
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Determine the amount of capital you employed in the deal: Add up all the costs associated with purchasing the property. This includes the purchase price, SDLT, legal fees and refurb costs.
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Calculate the Net Profit: Calculate the net profit generated by the property upon sale. To calculate the net profit, subtract all the cost in point 1 from the sale price.
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Apply the Formula: Divide the net profit by the total investment and multiply the result by 100 to get the ROI percentage.
For example, let's say you purchased a property for £150,000 and incurred £10,000 in fees (SDLT, legals, etc) and spent £40,000 in renovations, resulting in a total investment of £200,000.
You sold the property after renovation for £300,000. The net profit would therefore be £100,000.
ROI = (100,000 / 200,000) * 100 = 50%
In this example, the ROI on the property purchase is 50%. ROCE is typically used as a measure for projects you are flipping or can be used to calculate how your portfolio is performing as there may be additional equity in the property that could be utilised elsewhere.
Gross Yield = (Gross Annual Income / Property Value) * 100
Here's how you can break down the calculation:
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Determine the Property Value: This is the current value of the property after refinance at the end of the refurbishment.
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Calculate the Annual Income: Determine the income generated by the property on an annual basis.
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Apply the Formula: Divide the annual income by the property value and multiply the result by 100 to get the yield percentage.
For example, let's say the property is worth £300,000 like the previous example, and it generates an annual income of £20,000.
Gross Yield = (20,000 / 300,000) * 100 = 6.66%
In this example, the gross yield on the property purchase is 6.66%. The gross yield is used to give a quick snapshot of the deal and can be used to compare with other opportunities as it is consistent across all properties.
Net Yield = (Net Annual Income / Property Value) * 100
Here's how you can break down the calculation:
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Determine the Property Value: This is the current value of the property after refinance at the end of the refurbishment.
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Calculate the Net Profit: Calculate the net profit generated by the property annually. To calculate the net profit, subtract all the property-related expenses (such as mortgage payments, insurance, maintenance costs, property management fees, and utilities) from the total income generated by the property (rental income).
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Apply the Formula: Divide the net annual income by the property value and multiply the result by 100 to get the yield percentage.
For example, let's say the property is worth £300,000 like the previous example, and it generates an net annual income of £10,000.
Net Yield = (10,000 / 300,000) * 100 = 3.33%
In this example, the net yield on the property purchase is 3.33%. The net yield is specific to your own circumstances as the costs can differ depending on your situation (e.g. a cash buyer does not have to make mortgage payments meaning their net income is higher).
How do you know which metric to use to determine what is a good deal? The answer is that it totally depends on your circumstances and what works for you.