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Comparing deals and calculating ROI


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Hi all, looking for some guidance here please!

 

I'm in a position where I'm ready to invest in a couple of properties.  I have the funds and an idea of where I would like to invest, but would like to ensure that when I'm comparing properties it is offering a true like-for-like comparison between properties, is representative of what I can expect to achieve when the property is eventually let out, and is generally considered a good investment.  In particular I am unsure exactly how best to calculate the return on investment.

 

I've (unsuccessfully) tried to raise this as an "Ask Rob & Rob", so figured I'd put it out to the masses.

 

I've heard Rob & Rob mention on podcasts that they typically don't entertain investments that have less than 10% ROI, unless there are other mitigating reasons (particularly strong capital growth potential, for instance).  I am interested to hear what other investors' benchmarks are, and more importantly how this is calculated.

 

10% seems like a reasonable target, as it is a good return and allows for a buffer in case of unforeseen market changes (interest rate rises etc.).  Most of the properties that I am looking at have an ROI of between 7-10%, but this can very much depend on what I am factoring into the equation.  This is where I would like some advice / guidance.  As it stands, my ROI calculation consists of the following:

 

Capital Invested:

 

- Deposit

- Stamp Duty

- Legals

- Costs to get the property ready to le (refurb, furnishing etc.)

 

Income:

 

- Rent (easy!)

 

Expenses:

 

- Mortgage interest

- Service charges, ground rent etc. (where applicable)

- Letting costs / management fees

- Insurance

- Maintenance costs / allowance

- Void allowance

 

 

It is those last two expenses in particular that I am interested to hear about, as I'm unsure whether these should be factored into the ROI calculation.  It is obviously prudent to factor in an allowance when assessing cashflow in case these events happen, however I'm not sure this would be included in the ROI targets that R&R are looking for.

 

If 10% is a general indication of a good investment I just want to ensure that I understand how that 10% is calculated so that I know whether my own deals offer comparable value.  I appreciate that targets will differ from investor to investor, and situation to situation, but any guidance on generally accepted practice for calculating ROI will be very much appreciated.

 

p.s. - I am also assuming that ROI is always calculated as pre-tax ROI...?

 

Thanks!

Tom

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Hi Tom

 

This is a topic that I have covered a reasonable amount on my own blog and podcast; see here for a podcast episode (Incl transcript and some extra resource links): http://www.thepropertyvoice.net/building-on-solid-foundation-property-criteria-checklists-pvp-s1e03/

 

I think you captured most of the general headings above. The obvious omission relates to finance-related costs such as broker, lender and survey fees / costs. When you buy a new property, these will effectively form a part of your starting capital investment in cash terms and so need to be added in as well. Afrer a period of time, you may need to refinance and then these costs are usually classed as running costs to deduct from the rental income in cash terms at least (accounting treatment varies!). For those not using a mortgage, substitute deposit for the full property purchase price.

 

With an established property, calculating ROI is quite straightfrward as long as you have captured the figures somewhere. It gets a little trickier when trying to predict things for a new investment, so we have to make some assumptions. If we have other similar properties, this can help of course.

 

However, aside from getting quotes and estimates (e.g. letting fees, insurances, etc.), we can also make an educated guess with the big two you are struggling with: voids & maintenance.

 

Voids will vary depending on a number of factors, including local supply and demand, appeal of the property, your target rent and such like. The NLA published average is around 3-4 weeks void per year, so that's a decent benchmark for you to use. However, some landlord / investors have tenants that stay for years and rarely have a void, whilst others seem to have the odd property that 'sticks' on the market before letting and has a higher tenant turnover. Using the NLA average is a decent start but make sure you do your local rental market due dil to see how hot or cold the local market is for your particular property type for a more accurate estimate.

 

Maintenance, again will vary on a number of factors, including, property age and condition, how recently it has been updated / refurbished, quality of fixtures, fittings and appliances, type of tenants (how many, pets included, etc.), frequency of refresh such as repainting, structural soundness (and responsibility), existince of any warrantties / insurances, and so on. A decent stab is probably around 10% of the gross rent per annum for the more regular items of maintenance, although many landlord / investors budget nearer 20% p.a. for an older style property. Some costs will occur annually regardless, such as gas safety inspections, some every now and again, such as incidental repairs and replacements (carpets, white goods, repaint and so on) and others only occiasionally but can be quite 'lumpy' (roof, windows, boiler / GCH, etc.). This is why some people can get a bit caught out by maintenance costs. They can probably cope with the smaller items arising, but some fail to set aside sums to cover the larger spend items that happen periodically. The safest best is to set aside a decent chunk or have a specific conteingency fund to cover maintenance spend and don't forget the 'lumpy' spend every several years when estimating this sum!

 

As for ROI targets, that is a purely personal decision. To some beating the bank may be sufficient enough, whilst for others, they seek aggressive double-digit returns. There is also a risk-reward trade off to take into account, which includes things mentioned here (eg voids & maintenance), along with other factors like interest rates, local supply & demand, contingencies and so on. Higher returns often come with higher risk, so do keep that in mind. Equally, as you alluded to...return should be once ALL costs are taken into account and I have seen many an investor fall into the trap of omitting to account for some costs...of which there are many! My personal KPI is 15%+ ROI for BTL if I follow my recycling of cash strategy. It can be lower or higher depending on different circumstances or approaches. However, I would say that achieving 15% ROI is not an easy exercise by any means and this comes with a lot of experience. A safer bet for a newer investor going it alone might be in the range that you have found yourself to be fair. It also varies depending on location.

 

Some people also factor capital returns into their ROI calcs after a period of time, however, looking forward is pure speculation and so I definitely do not. Looking back it can be quite nice to do that, depending on when you do it, of course! As for tax, all of my examples above assume a pre-tax ROI as that is the simplest way to run the numbers. There is nothing stopping you from doing a post-tax calculation and throwing in tax as an expense, although this can get quite complicated when looking at individual circumstances. Again, it is easier looking back at the property(s) over time, so keep your tax returns in one place and do that exercise each year once you start.

 

I hope that helps you...and others asking the same question.

 

Best

Richard

Richard W J Brown a.k.a. The Property Voice

Property Investment Strategist

10%+ ROI property deals every week: check out PROPERTY DEAL TIPS
Amazon best-selling author Property Investor Toolkit & #PropTech, YPN Magazine columnist & PODCAST host

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  • 3 weeks later...

Thanks Richard for your very detailed response, that's really useful!  Certainly gives me something to go on and consider.  We're in it for the long haul so ROI in the short term isn't necessarily the be all, but obviously want something that makes our money work efficiently.

 

ill be sure to check out your blog.  Always looking to learn more.  I think I've heard a couple of your podcasts already come to think of it so will try and listen to a few more of them too.  

 

Happy new new year to you!

 

Tom

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