Property people often talk about 'Returns' and 'Yield' when describing a property investment. How can you quickly calculate these values in a property?
This quick-fire calculation can help you see the difference between a good and bad investment - a great skill to learn if you want to know How to Invest in Real Estate.
Why complicate things with long formulas, when the simplest option will do? Property valuers and professionals often use complex calculations to work out these values. But as property developer, you can save time by using this easy method to do these calculations on the fly!
Use the 'golden triangle' below to work out your property return in a flash!
Step #1 - Calculate your 'N.O.I.'
At the top of the pyramid is N.O.I. or 'Net Operating Income'. This is the income that our property receives, after expenses have been deducted.
NOI = Income - Expenses
The NOI is calculated annually (over 12 months)
A property with relatively low expenses will generate a high NOI and is therefore a more attractive investment. Remember, expenses include things like utilities, rates and taxes, management fees and maintenance costs.
"Pro tip: Keep expenses low to boost your N.O.I - your income after expenses essentially represents your your profit!"
– Justus van der Hoven, Property Expert
Example: A block of flats earns R100, 000 of revenue per month. There are R20,000 of expenses. What is the NOI? Remember to work it out over 12 months.
Gross monthly income is R100,000 – R20,000 (less expenses) = R80,000 net monthly income. Now let’s calculate the annual income? NOI = R80,000 X 12 = R960, 000.
Great! We have the first part of the calculation. Let’s move on to the next step!
Step #2 - Capital
Your capital is the amount of equity that you invest in the deal. This is the total development cost. It is also the same as the total purchase price of a property.
Example: You purchased land for R3,000,000, and built a building for R7,000,000. Your cost to upgrade the property come to R2,000,000. What is the total amount of capital invested?
Land: R 3,000,000
Building: R 7,000,000
Upgrades R 2,000,000
TOTAL: R12,000,000
Step #3 - Calculate Return
Now that we have our NOI and total Capital, we can use the 'golden triangle' to work out our Return.
The thin lines inside the pyramid represent 'division' or 'multiplication'. The horizontal line means we divide the elements on the triangle, and the vertical line means we multiply.
So to work out our % Return, we can see NOI is on the top of the pyramid, and Capital below it. The horizontal line between them means we divide NOI by Capital.
Continuing from our example;
% Return = Annual NOI/ Property Value (or cost) = R960,000 / R12,000,000 = 8% Return
This is the same exact thing as the 'cap rate' that an investor uses when using the reverse calculation. Another word used to describe this return is yield.
Summary
In short, you can use the 'golden triangle' to calculate returns, how much capital you need, or the NOI that is required to achieve a specific return.
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