# Alternative calculation of yield - better?



## Alexmartin (6 May 2013)

Ive been reading some other forums today and have seen a different calculation for yield come up a couple of times.
One person said that they paid out €20,000 between deposit and all other expenses when they bought an investment property.
All expenses, like repairs, property taxes, income taxes, mortgage, repairs, EA etc are paid from the rent of €1000PM or €12000 per year.

Whats left in their pocket, so to speak after all of that is €3000.

So on an investment of 20,000 he makes €3000 per year, even after all taxes are paid.

His "yield" on his investment is (3000/20000) * 100 = 15%

What does everybody think of this?

He put in 20k which makes him 3k per year after tax.
And that doesnt even take account of the scenario that when the mortgage is paid the property is all his.
Phenomenal.  

I think he calculated yield in the normal way at about 9%, but his "return on investment" is a better way to look at it i think.

I've read about this in a lot of places over the last few months, but really gace it some thought today.


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## ronaldo (6 May 2013)

This view of "Return on Investment" sounds to me like a calculation being done by someone trying to justify a bad investment.

What about "Return on Capital at Risk"? At the end of the day, you may have only put down a deposit of 10% but you are still exposed to 100% of the falls in the value of the property.

If you pay 10% down, including fees, and work out the return on this 10% invested as 15%, then the return, in reality, equates to 1.5% of the value of the house. In other words, the 60% drops experienced in recent years wipes out decades and decades of returns.

In my opinion, there's nothing phenomenal about it and you're better just using the traditional method of calculating yield.


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## Joe_90 (6 May 2013)

+1, following your logic the more you borrow the higher the yield, if he borrowed €10k more the income would be €2500 for a €10k 25% return.


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## Alexmartin (6 May 2013)

All issues i had with it too, before i thought long and hard about it.
His 10% yield by normal calculation method is very good so i wouldnt call it a bad investment at all.
 I cant fault investing a one off 20k to return 3k per year as hard as i try.
Then in 25 or 30 years he owns it outright too.
You are right that he is exposed to falling values, but no more than he normally would be. Bottom line is you wont get that return on 20k anywhere.  Maybe Japan.


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## Brendan Burgess (7 May 2013)

The yield is the income over the capital employed.

If he gets a return of €3,000 on an investment of €20,000, then his yield is 15%. 

However, he must also factor in the rise or fall in property values. 

If the property cost €100,000 and has fallen by €10,000 , then he has a negative yield of €7,000 on €20,000 or 35%. 



> And that doesnt even take account of the scenario that when the mortgage is paid the property is all his.
> Phenomenal.



This is the wrong way to look at it. If he has paid off the capital, then he  has obviously invested a lot more. So if he borrowed €80,000 and has repaid it, then his investment is €100,000. If he has net income of €3,000, the yield is 3%. 

It's a bit more complicated, but he should also calculate the yield on the revised value of the property, not the purchase price.  Leave borrowings out of it for the moment, as it complicates it. Say I bought a property for €10,000 cash  20 years ago, which is worth €100,000 today.  If I am getting €3,000 a year net, the return on my capital today is 3%, not 30%. 



By the way, your figures look wrong. 



> I think he calculated yield in the normal way at about 9%,



€3,000 would be 9% of €33,000.
So he only borrowed €13,000.
And he is getting rent of €12,000 on an investment of €33,000 

If you are thinking of investing, do the numbers yourself.  

Gearing is great for increasing the yield, but there are thousands of insolvent property investors in Ireland today who thought that the risks were theoretical.


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## Joe_90 (7 May 2013)

Think the €12,000 is 9% so the cost is €133,333. 
Just to take an example:
So borrowed €113,000 @ 4.5% over 20 years is €700 per month or 8,400 pa, if he has no other expenses then the tax could be €4,250 so total deductions €12,650 so I'm not sure where the €3,000 is coming from.


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## Brendan Burgess (7 May 2013)

I think it's worth emphasising the risks of borrowing , as most people don't understand them or forget about them. 




 | No borrowing | Borrowing 90%
Investment|€100,000|€10,000
Borrowing|0|€90,000
Capital gain 20%{br} Return on investment| €20,000{br} 20% |€20,000{br} 200%
Capital loss 20%{br}Return on investment |-€20,000{br} -20%|-€20,000{br} wipeout
This is why so many people have lost huge amounts on geared bonds and  investment properties in recent years.


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## Alexmartin (7 May 2013)

I understand where you are coming from about gearing. Nothing new there. I can't find the example I quoted but here is another I found. 


http://touch.boards.ie/thread/2056929056/5

About half way down the page


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## Brendan Burgess (7 May 2013)

Alexmartin said:


> I understand where you are coming from about gearing. Nothing new there.



There might be nothing new, but there was no mention of this risk in your original post. 

And I have used a similar example, to explain to some very smart people why they lost a big part of their investment in a geared property fund, and it was completely new to them. 

Brendan


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## Alexmartin (7 May 2013)

I was talking to my brother in law this evening about this as he has an investment property at the moment that he bought many moons ago.
He was telling me he shelled out €11000 in total and kept everything in one bank account for that apartment.  Rent goes in.  Expenses and taxes go out.  He has never spent anymore than that initial 11k that has not come out of the apartment bank account.
There is over 30k in that account now and the apartment mortgage will be paid off in another 8 years.  He said he doesnt care if the price goes up or down because it will all be paid off at the end of the mortgage term anyway and he will own it outright, never having spent over that initial 11k.

And another link I just found on the Irish landlord forum

http://www.irishlandlord.com/forum/showpost.php?p=12352&postcount=10


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## Brendan Burgess (7 May 2013)

Hi Alex

Again, I would point out that this is the wrong way of looking at it.  

He has an investment today worth,say, €300,000.  Is he getting a good yield on that. The €11,000 is completely irrelevant. 

Allocating money to "pots" like this is not a good idea. If he has a home loan at SVR, he would have been much better to use his "rent" money to pay it off.  If he has no other borrowings, he may have been much better to put the cash in the stockmarket. 

Brendan


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## Bronte (8 May 2013)

Brendan Burgess said:


> . If he has a home loan at SVR, he would have been much better to use his "rent" money to pay it off. If he has no other borrowings, he may have been much better to put the cash in the stockmarket.


 
Not sure I'd agree with that. You can lose absolutely everything on the stock market and many people have. In the example that Alex just posted the person renting will always have the property no matter what way the market is and he can presumably ride out the current practically non existant property market. It's the way I view rental investment market too. Yea sure I've had massive capital losses, on paper, same as I've had massive capital gains, on paper, but I'll still have the bricks and mortgage. In any case when the mortgages are paid off there is a good income, or the option to sell and invest in ?


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## cremeegg (8 May 2013)

I hope I know what I am talking about here as this is a large part of how I make my living.

Alexmartin's calculation is correct, there is nothing "different" about it, that is the standard way to calculate the yield.

You see people quoting the gross rental yield, that is the rent divided by the purchase price. Which at the present market in Ireland goes roughly from 5% to 10% on residential property. However this should only be used to make a comparison between properties, it is not a method of calculating the return on your investment.

As Joe90 points out the more you borrow the higher the yield, so long as the interest rate is less than the return. Joe90 seems to think this is illogical, but it is not, it is correct. Higher borrowing increases both return and of course also the risk.

All this ignores the fact that you have borrowed a big lump of money. If your business is renting property and not speculation on the price of property that is not relevant to the RETURN.

Next issue cash-flow. If your borrowing is €130,000 and you repay capital at €3,000 a year it will take you over 43 years to repay the loan. To get rental income of €12k I think you would need to spend €150k in the current market.

Some posters are concerned that the price of property may fall. This is not a fundamental concern if your business is renting. A particular instance from my own experience. I bought an investment property in 1999 with a 10% deposit. Every year since I have collected the rent and paid the mortgage. Emotionally the up-up-up and the down-down-down of the property market has been huge but in practical terms it has been irrelevant. I don't know what I will get for the property when I retire, but I can choose to retire from the rental business when I like, or semi-retire by passing to an agent, or getting a really good tenant at a lower rent, or maybe my kids will take it on.

I don't believe that you can net €3,000 from rental income of €12,000, half that would be good. See my attached calculation. 

Although if you are skilled at the business you may after long searching identify a property with unrealised potential, perhaps to increase the rent or perhaps it is on sale at a low price for a reason which you can remedy. I once bought a property about €20k below what it might have cost because of a very bitter boundary dispute. Instead of shouting at the neighbour I asked him what he wanted and paid €1,000 to give it to him. The neighbour got €1,000 for being difficult but I got €19k for very little.

In the renting business like any other there is money to be made if you work at it and know or can afford to learn what you are doing. 

You need to know buying property, borrowing money and dealing with tenants. These are three different things. Many people underestimate the need to understand borrowing, especially during the boom when there were many different products on the market 

Unlike any other business you can get leverage. If you can deal sensibly with that, i.e. not use it to over pay for a property, this is a unique advantage to the business.


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## cremeegg (8 May 2013)

Cost	       150,000		
Deposit	20,000		
Borrowing	130,000		

Interest at 5%	6,500		

Gross Yield 8%

Rental	             12,000		
Allowable Interest	4875		6500*0.75		
Ins	                          400		
PRTB	                          90		
NPPR                 	200		
Advert                	50		
Maintenance	        600		
Contingency etc	        800		approx 4.5 weeks void

Deductable expenses	7,015		

Taxable profit	4,985		

Tax estimated	2,493		


Income	12,000		

Interest cost	6,500		
Other Expenses	2,140		
Tax cost	2,493		
Total	       11,133		

Profit	    868		

Return	4.34%


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## Brendan Burgess (8 May 2013)

Hi cremeegg

That is a great post. 

Would you consider starting a new thread and we could make it a Key Post? 

Something along the lines of 

"A long-term approach to property investment"  or "one property investor's story" 

I think it would be very useful for potential investors to read before investing. 

Brendan


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## kkelliher (8 May 2013)

Agree with Brendan, very good post and bang on the money.

I am in a similar position on property and to be fair rise and fall in values, and negative equity is completely irrelevant unless you are looking to sell a property. There are many properties turning a decent profit in the rental market whilst also in negative equity.


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## ronaldo (9 May 2013)

I'm not slating your figures or anything, just curious.

Is there a reason that you include Contingency as deductible against profits for tax but not as an expense when calculating the profit itself? It impacts the figures for the above, theoretical, scenario significantly.


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## Bronte (10 May 2013)

cremeegg said:


> You need to know buying property, borrowing money and dealing with tenants. These are three different things.


 
Your whole post was great Cremeegg and I particularly liked the bit quoted above. I had never thought of it that way before but it's certainly true. 

If you bought in 1999 then presumably there is no NE, there wouldn't be for a lot of people, but even if in NE it doesn't matter. And for anyone entering the property market now as an investor there are good yields out there with the possibility of capital appreciation. Which would be a bonus.  But the more important thing to get right is the 3 points you mentioned.


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## cremeegg (10 May 2013)

ronaldo said:


> I'm not slating your figures or anything, just curious.
> 
> Is there a reason that you include Contingency as deductible against profits for tax but not as an expense when calculating the profit itself? It impacts the figures for the above, theoretical, scenario significantly.



Thanks Ronaldo for pointing that out. It was not intentional, I have edited the post to correct.


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