Investment properties are a great way to generate income, but how do you know how to pick a property that is going to give you the best return on investment?
Here are some things you need to evaluate before taking the plunge into the investment world.
Your mortgage repayments
If you borrow to invest, you will have to pay the property mortgage. Don’t rely on rental income to cover the mortgage – there may be times when your property is empty.
Many people buy investment property with interest-only loans, but remember the interest-only period will end after a certain time. This means your repayments will increase to pay the amount borrowed, plus the interest.
Tenants usually pay their own electric bills, but landlords often pay for water and general rates. This is especially true if the property is a multi-unit building. If the property you’re considering is already rented, find out what utilities the landlord pays. Then conservatively estimate how much they’ll cost.
Property management fees
If you plan to hire a property manager, account for the expense. Also, look closely into what services they include or offer. You want to be getting the best possible service for your investment. Cheaper isn’t always better!
You need to know how much rental income a property will generate, especially before making a purchase. If the property is already rented, this is easy. Better yet, if the property is occupied, ask the current owner for a detailed rental history. This not only lets you know how much rent has been generated by the property but can also give you good insights into vacancy trends. If the property is owner-occupied, you should engage a professional property manager to perform a rental appraisal.
Gross rental yield
Here’s how to calculate gross rental yield:
- Sum up your total annual rent that you would charge a tenant
- Divide your annual rent by the value of the property
- Multiply that figure by 100 to get the percentage of your gross rental yield
Here’s an example of calculating gross rental yield.
Let’s say, you receive $30,000 each year in rent, and the property is worth $500,000. Your gross rental yield is equal to $30,000 ÷ $500,000 X 100 = 6%.
There is no specific way to determine whether the rental yield is ‘good’ or ‘bad’ it all comes down to each property’s various features. It’s easy to assume that a higher rental yield means a higher return or a greater property value, but this may not always be the case.
While some investors are happy to carry a loss (using negative gearing to offset their income), the best measure of property performance is to calculate the profit once you subtract your rental expenses from your rental income. Measuring your cash flow is the easiest way to identify whether your investment property is producing a profit or a loss.
Monthly Rental Income – Monthly Rental Expenses = Cash Flow
When calculating cash flow, don’t forget to include all your rental expenses to ensure an accurate result. Mortgage repayments, insurances, property taxes, management fees, accounting fees, body corporate fees, maintenance costs, utilities and vacancy carrying costs should all be included in your cash flow calculations so you know exactly where you stand.
Return on Investment
Calculating your return on investment (ROI) is one of the best ways you can analyse the performance of your rental property. By accounting for everything, including cash flow, equity, and investment costs, you can calculate the annual return on your investment and identify how well your investment is really performing.
(Cash Flow + Principal Payment) x 12 / Total Investment Costs = ROI
Calculate ROI by first measuring your annual return. This is done by adding together your monthly cash flow and monthly principal payment (just the principal, not the interest). Then multiply this amount by 12 to get your annual return. To calculate your ROI, divide your annual return by your total investment costs. Calculating ROI also helps compare returns on multiple properties worth different amounts.
We hope that these tips help you decide on your big investment purchase. If you want to chat with our sales team about buying an investment, or you are a landlord that is looking for a property management service, give us a call today on 3202 3040.
TAYLAH ANTONIOLLI – MARKETING & COMMUNICATIONS COORDINATOR
07 3202 3040
A go getter and doer, Taylah is a no excuses, get the job done kind of girl. With a strong work ethic and high attention to detail, Taylah is happy to help out wherever she can. Armed with a degree in business specialising in marketing and public relations Taylah brings fresh ideas and innovation to the iThink team.