4 Ways to Measure Property Performance
It is important that property investors treat their investments as a business. What can start out a ‘side hustle’ can quickly grow and return more cash than a salary. A business should choose a number of Key Performance Measures (KPI’s) and metrics in order to decide on whether a new investment is worthy of their attention and to measure the performance on existing stock. This short guide will provide a number of performance measures that I utilise in my own property portfolio and help you to measure your property performance.
Gross Yield. Gross yield provides an indication of the likely return of a property. It should only be used as a quick measure when you are pressed for time in order to see whether a deal is worth investigating further. It is of limited value for detailed investigation into a property’s performance as it is more applicable to cash buyers, which the majority of us are not. Still it provides a useful barometer of likely property performance.
Gross Yield = Expected Annual Rent / Purchase Price.
What yield is acceptable to each investor will vary depending on what your objectives are. The investor who seeks capital appreciation may select a lower yield on the hope that they are compensated through greater than average capital appreciation. Meanwhile the yield investor may choose a higher yield investment because they want the certainty of cash flow. This could be by accepting that capital appreciation may be low.
I think it is important to strike a balance of a reasonable yield with a higher than average expected capital appreciation, although this last bit is difficult to plan for. You need to ensure that whatever yield is acceptable is going to provide sufficient cash flow in order to pay for itself and allow some cash leftover for repairs and a bit of profit.
Return on Investment. This is my favourite measure of property performance because it enables you to compare your return to other investments.
Return on Investment = Annualised Net Return / Cash Invested.
Many investors focus purely on rental return when looking at ROI. However I did not get into property solely to get rich from rental profits. Capital growth and buying well also play an important part of my strategy and so are also included in my analysis.
My purchases have up until now been on 5 year fixed mortgage products. To calculate my ROI I include the cash rental return, increase in value of the property over the five year period (through fair market value at end of period) and my assessment of the discount I achieved against fair value. I combine these to give me a total return annualised ROI. My hope is that it will be at least 20% per year which will enable me to draw out all of my initial investment at the end of the period at the point of refinance (through remortgage or cash flow). This strategy requires an element of capital growth (which is difficult to forecast) and therefore I am looking to invest in areas that I assess will have a higher than average capital growth. I also look to buy at a discount in order to enhance my return.
Return on Realisable Equity. This is a less well known measurement of the performance of rental property. It is calculated similarly to ROI but with a slight variation.
Return on Realisable Equity = Annualised Net Return / Realisable equity*
*Realisable equity is the amount of money you would have left after sale of the property and after paying frictional costs and tax.
This metric is useful because it gets you to look into how much money you will actually be left with after a sale. Fees and tax are likely to take a significant dent out of your investment and need to be factored into your calculations. Also are you really going to get a top sale price if you are in a rush to sell or decide to sell with a tenant in situ.
Tax Tip. You also need to avoid a situation where you have remortgaged a property to such an extent that the taxation due will be greater than the value of the deposit. This will make you a mortgage prisoner, reliant on further appreciation before you can access any equity. Take care here. Using return on realisable equity will ensure you keep on top of this consideration by remembering to think about post tax returns.
Absolute Return. You need to know how much cash is going to be left in your pocket each month after paying all expenses (those you pay now and those you may have to pay down the line). You should ensure this amount fits into your goals as it will tell you how many properties you need to purchase in order to meet your financial freedom figure. It is great to look at high yielding properties, but what if that high yielding property is only going to make you 100 pounds per month? How many of these will you need to buy to get to where you want?
Hopefully these metrics are of use to you and can be incorporated into you property businesses in order to help you to analyse deals and existing performance.
If you need help understanding what performance measures are suitable for your portfolio then please get in touch with us.
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