Saturday 3 April 2010

Return on Investment: Calculating gross yield

How do property investors know which property to purchase? One of the assessment methods used regularly is termed as Return on Investment (ROI). It is not the only method that investors use to calculate returns; however, it is the most widely used. 

ROI, also known as Yield, is calculated to determine the feasibility of a property investment. It is designed to assist the investor to answer, ‘Is this investment worth it?’, ‘What will I get back in return?’ and ‘Which investment options are more attractive?’  

It indicates cash flow of an investment over a specific period of time, usually a year. Therefore, the higher the percentage of ROI/Yield, the better rated the property investment opportunity is.  As with any investment, before you put your time, energy, effort and money into it, you must have an indication of the kind of returns, including an indication of when it is expected. In this article, “Yield” indicates an annual rate of return, unless otherwise noted. 

Note: Investment property refers to a property purchased for the sole purpose of earning a return on the investment, either in the form of rent or capital gain. The owner does not live in the property.

How to calculate yield?
In its simplest form, the profit of an investment is divided by the cost of the investment (Yield is usually shown in percentage). Often, it is best to determine each investment over the course of a year to find out the yearly Yield.

Gross yield
For example:
Investment property     RM500,000
Renovations                 RM80,000
Rental                          RM3,000 per month / RM36,000 per year

Gross Yield = Annual Rent / Total Cost of Investment
RM36,000 / RM580,000 = 0.062 = 6.2%

However, to arrive at a more accurate Yield (actual returns), you must deduct other costs such as Maintenance Charges, Sinking Fund, Management Fees, Insurance, Quit Rent, Assessment, Estate Agent and Legal Fees (where relevant) and other expenses.

Calculating the Yield for each property investment will aid in comparing, shortlisting and selecting investments that bring the best returns to you.  However, at present we base our returns on the yearly rental and not the ultimate returns you will get when you sell the property.  Yield and expected Capital Appreciation must be considered together, in order to make better decisions on the investment option.  Some properties might be lower on yearly Yields but over a shorter period of time, it can double in property value.

The preferred Yield percentage
As a general rule of thumb, seasoned investors would go for a property investment which has a nett yield that is twice the fixed deposit rates, which in this case would have to touch no less than 5%. 

How can this be achieved?  There are only two ways, as per the formula – either rental can improve or reduction in purchase price.  For example, if the seller is willing to consider RM450,000 and a more reflective rental is RM4,000 per month.  The gross yield now hits 9.1%.


P/s: Baru aku tau lepas baca ni