Top 5 financial criteria’s to evaluate a rental property investment?

Hi Mate,

Expand your acronyms and your equations for them – that way we are all on the same page and know you’re coming up with the values associated.

Cheers

Ben

Hi Mate,

I try not to use acronyms with people I dont know, particularly when they arent widely used or are based on formulas that aren’t necessarily always the same.

As for the above:
1) Gross Rental Return (GRR)
GRR=(Annual Rent/Purchase Price) x 100
Agreed, I call this rental yield.

2) Return On Investment (ROI)
ROI=(Annual Profit/Purchase Price) x 100
What is annual profit? and is this a after-tax or gross amount? Realised or unrealised gains? If the profit considers that it has been held for a year do you consider inflation and what the real worth is?

3) Cash-On-Cash Return (CoCR)
CoCR=(Cash Back/Cash Down) x 100
As above. Before or after tax “cash back”? And what is your definition of cash down? Total initial outlay? That’s what I would go with.

4) Growth On Equity Return (GoER)
GoER=(Expected Annual Growth/Current Equity) x 100
Why would you use a GoER anyway? Would you not want to work numbers on total growth on your property? just working out what the percentage growth on equity is and not the total amount of equity usable…. I dont see where you would use such a formula, or how it would dictate into your rationale for buying something (see below).

5) Net Profit Percentage (NPP)
NPP= [(Annual Cash Flow + Annual Expected Growth)/Cash Down] x 100
I personally dont use expected growth rates in my evaluation figures because it is really speculation. What is to say an area will go up 2%, 4% or 6%? I’m all for considerations of different growth rates, but at the end of the day I don’t use this formula when I evaluate purchasing a property.

I do consider growth but not in a formula as above.

The thing is with the formulas, what percentage you need or you consider to be acceptable comes down to your strategy and where the next purchase comes into your goals.

For example (simply) cashflow vs growth. If you wanted a cashflow property then the above figures would all be cashflow biased. If you wanted growth, then perhaps your rental yield (you call it GRR) may be quite low. It depends.

And then there are added considerations. Say you have a house and an apartment both with 7% yields. An apartment is going to have extra (standard) costs of strata fees, sinking fund fees etc., so that eats into your margins.

I am a heavy number crunching guy when it comes to looking at the next investment, and I’ll tell you what I use.

Rental yield = annual rent/purchase price x 100.
This is a good roundabout percentage that gives you an inclination on cashflow. I tend to look at property over 6 per cent where possible, however again it comes down to your strategy (e.g. a buy hold/sell with negative cashflow may have a lesser yield but can be bought $30k under market value).

first I work on cashflow returns as this is easy.

Cashflow before tax.
rental yield – interest – outgoings

Cashflow after tax.
taxable income * tax rate = tax payable1
taxable income – (rental yield – interest – outgoings – depreciation – (loan costs/5)) * tax rates = tax payable2
tax difference = tax payable1 – tax payable2

Cashflow = cashflow before tax + tax difference

tax rates that I use in excel as a guide =sumproduct(–(C30>={18201;37001;80001;180001}),(C30-{18200;37000;80000;180000}),{0.19;0.135;0.045;0.1})

then I work on capital
Total initial outlay

Sales costs (selling price based on CMA’s)

Cost base

CoCR (but I use after tax profit, so working through CGT etc. and I do them for holding for 12 months and one for less (full CGT))

Tax considerations in trust structures (includes parallel figures for the cashflow above as personal income doesnt come into play for my cashflow/tax credits)

I also work out my equity access, this % is dependent on the type of property – remember the bank will loan different LVR’s dependent on the property type and use.

Then after working out my equity access, I work out my after settlement cash availability vs my total initial outlay.

When you’ve done the above you should have:
before and after tax flow (in personal names)
CoCR if sold (at different CGT)
Equity accessible

And then you can work out your accessible equity – total outlay and see how much it will “cost” you to pick this property up (not including ongoing interest if you’ve used equity) out of your capital base.

Anyway hopefully there’s a few bits and pieces in there to get you thinking. A lot easier on a spreadsheet, and again, this is just a guide for figures.

At the end of the day you need to do an evaluation far beyond the numbers. The above might all be terrible but the property is on two lots
and you can knock down and develop. That would be another set of figures for evaluation.

It all comes back to strategy.

Good luck and happy investing.

Ben

• This reply was modified 9 years, 6 months ago by  Stannis.

Ben,

I totally agree with you. It all depends on our strategy.
My strategy is to hold long term and rely on my strong personal cashflow, hence I am not too concerned with CGT and equity.
I am more focused on low purchase price, rental return, low maintenance and location, location,location.

So I select a few post codes with robust price increases. Then I record all the sale and rental advertisements for a each postcode for a specific period of time.
Just to add more calculations to your hefty calculations, I calculate the average rent per bedroom, property price per bedroom and property price per sqm.
So I know which area’s got the better return and the next time an interesting property come up, I know whether it is overpriced or a good buy.

Just my 2 cents, :)
Catts