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Gross yield, net yield, return on investment – all this language might be scary and confusing, but it’s really quite simple to work out.
Any investor will use these metrics to measure how investable a property might be.
Some people may well mention other metrics but for me and for 99% of property investors you only need to understand the big three!
Gross Yield – Net Yield – Return on Investment (R.O.I.)
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So how do you work out the big three metrics that tell you if a property is viable as an investment or not? Well let’s start with…
GROSS YIELD
Gross yield = annual income generated by a property, divided by its purchase price.
Example:
Annual rent: £5,000 Purchase price: £100,000 Gross yield = 5%
Gross Yield will give you a very basic understanding of it’s profitability, however it’s not the best way to go! The reason is it does not take into account any costs and so it’s not a true picture of what will happen. You won’t actually generate 5% that figure is before any costs. Always remember that gross is before costs are deducted.
NET YIELD
Net yield is the annual income minus the annual costs, divided by its purchase price.
Example:
Annual rent: £5,000 Annual costs: £1,000 Annual profit = £4,000
Purchase price: £100,000 Net yield = 4%
So what costs could we be deducting from the rental income?
Mortgage payments
Management (letting agent fees usually 8 to 12% per month)
Insurances (buildings insurance, contents insurance if applicable)
Maintenance and Repairs (always wise to factor this in)
Voids (the property being empty)
Service charge and ground rent (if applicable)
So now we have a better (more true to life) measurement, because we accounted for all the running costs you might incur with the property ongoing.
So NET YIELD is a popular and commonly used metric used by many property investors. When you talk yields with investors always be crystal clear that it’s either Net Yield you are talking about or Gross to avoid confusion.
So what about our last of the big three…
RETURN ON INVESTMENT (ROI)
Return on Investment (ROI) is the annual profit (income minus any costs) generated by a property, divided by the actual cash you've put in.
If you bought the property using a mortgage you would likely put in 25% of the purchase price (this is the deposit).
Example:
Annual rent: £5,000 Annual costs: £2,000 Annual profit = £3,000
Purchase price: £100,000 Mortgage used: £75,000
Cash invested: £25,000 ROI = 12%
You might be thinking, wow… 12% looks a lot better than the gross yield – this is because your only putting in 25% of the purchase price as opposed to it being based on 100% of the purchase price.
R.O.I. shows you exactly how hard your capital is working as it’s based on the money in the deal and the profits returned after costs.
SO WHICH CALCULATION SHOULD YOU USE?
Personally I have always preferred using good old, R.O.I. purely because it shows you how hard your money is working.
When all is said and done what you will find is most investors you will encounter, will want to know what the Net Yield is or what the ROI is. People may ask for other metrics such as ROCE (return on capital employed) Or ROC (return on cash) But effectively they are the same as ROI.
Generally ROCE is used to calculate how profitable a business is and includes tax liabilities. In property you should only worry about the big three.
WHAT COSTS SHOULD YOU ACCOUNT FOR?
This is a case of what suits one person will not work for others. As a deal packager you may well be dealing with investors who will purchase using bridging finance and so the ‘cash invested’ amount will differ and the ongoing costs whilst the bridging is active will ramp up the costs.
But let’s keep things simple. When we present the figures to an investor, we should just be consistent. One bone of contention that does crop up from time to time is… I have seen many investors complain that a deal sourcer has not included their sourcing fee in the costs. They have just added their fee at the bottom.
This could be looked on negatively as from the investors point of view they have to pay you a fee so therefore it’s a cost of acquisition. My advice is you do include it in as a cost.
For an idea on the common costs, check out the deal calculator here
Other Things to Consider
There are a couple of omissions to be aware of as investors may mention these. The first is Tax
What about tax liabilities? As an investor you should be aware of your own tax liability and the impact of buying an asset. However as a deal packager/sourcer – it’s really messy and complicated to incorporate tax into the mix. So if an investor mentions tax – point them toward a property tax specialist who can advise them properly.
As property deal packaging is all about analysis and looking at the data. We may have seen during our due diligence phase that actually - capital growth has added 15% to the property value in the last 5 years!
Surely that should be factored in?
Yes and no – historic growth is readily available data, but it’s all in the past. Historic growth is a good gage for future growth but it’s no guarantee. By all means share what has happened in the past – if it’s hugely positive then at the end of the day that will only have a positive impact on the investors perception of the prospective opportunity.
Final Thoughts
Many deal packagers / sourcers will ask me, what makes a good deal – what baseline figure on yields means it all stacks ups? The simple answer is there isn’t one.
One investor might be happy with a 6% net yield whereas the next investor might be demanding double digit yields. What works for one, will not work for another.
If you want some loose form of guidance so you at least know if something looks good (without an investor telling you what they want) go look at the averages in the area.
If you know 3 beds in Leeds are an average 7% net yield and you find one that give's you 10% then you’ll know it’s above average and it’s probably worth a closer look.
That being said you should always be driven by what your investor client wants. Then go and find properties that meet their investment criteria.
Investor first – property second. It’s the only way.
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