On a property forum I once asked what yield my fellow investors target and where they bought their properties to get that yield.
This was actually in response to being somewhat perplexed by a news article I had read criticising one of the prominent property ‘gurus’ of the day.
Now I have to say I had no connection with this ‘guru’; I’ve never met him or spoken to him and I’ve not been on his weekend seminar. However, I did join a couple of hundred people in a hotel near Victoria Station to attend his free “introductory” seminar to see what all the fuss was about. What I heard seemed sensible enough; his plan for buying high-yielding properties and refinancing to get his money back is a plan being followed by hundreds, if not thousands, of investors in this country with varying degrees of success. I know that, done properly, it can and does work. I had no reason to believe it doesn’t work for him.
However, this particular newspaper article did not agree. The journalist, I presume a young hack just out of college, obviously knew nothing about property investment, but was obviously under instruction from the editor to stitch the guru up no matter what. As a result the article put forward a number of non-points in an “Aha, told you so!“ kind of way, as if revealing some great conspiracy.
One of these “non-points”, supported by “expert evidence” from a reputable firm of London Estate Agents, was that it was impossible to obtain returns of 10% as claimed by the guru.
This assertion was, of course, complete nonsense (I and many other were regularly finding properties yielding 10% and more) and so I was now curious to see what other investor’s expectations were. Had yields plunged, and I’d just been lucky? Or, as I suspect, was the reputable firm of London Estate Agents only asked to comment on high quality, low-yielding properties, because in fairness, these are the types of property they typically deal in.
I can’t claim my mini-survey had any particular statistical relevance; I think I only got 3 replies. This suggested achieved yields of 6%-11% in different areas of the country. Perhaps of more interest is that everyone seemed happy to talk about yield in the first place. Those who’ve read my ebook The Successful property investor’s Strategy Workshop will know that I’m much more interested in the cash-on-cash return than the yield. This is nothing new. Far cleverer people than me have been encouraging us to look at this measure of performance from times long before I started investing in property. The yield can be a rough and ready indicator of whether an investment is interesting, but it need not bear any relation to the cash-on-cash return.
If you’re not sure what the difference is:
The cash-on-cash return is, very briefly, in its simplest form, the return or income expressed as a percentage of the actual amount of money you put into the deal, and is calculated as the rent divided by the amount of money you put into the deal, such as deposit, legal fees and other costs, times 100.
The gross yield is the rent expressed as a percentage of the purchase price and is calculated as the annual rent divided by the purchase price (plus costs) times 100.
The cash-on-cash return is often a more important indicator than the gross yield, as it shows exactly what your money is actually making, and will vary according to how much you put in.
But even this is not the full story, because return from the rent is only one of several potential returns receivable simultaneously from property.
For example, you might be hoping for, or even planning for, capital growth reflecting an increase in property prices generally. You may also undertake improvements or repairs, which disproportionately increase the value of the property. And there might be tax advantages to investing in property rather than in another asset class. On the down side, you might want to reflect within your overall return sums of expenditure you know will be required, and which will not positively impact your return. For example, essential repairs which only maintain the value, but which do not enhance it.
The difficulty has always been in calculating the overall cumulative return taking all these positive and negative influences into account. This is made ever more difficult when you realise that these are not constant and change over time.
By definition, the “cash-on-cash” return only calculates the return on the value and the expenditure at the moment the property is purchased and doesn’t truly reflect future expectations. Purists might argue that this could be achieved by manipulating the yield, but this is beyond the scope of most private investors.
So when you purchase a property you know rents will rise in time and want to reflect this. Also you know from having a planned maintenance schedule that repairs will be required on an irregular basis ie large expenditures in years 3, 7 & 10 on painting the outside, replacing the roof and repairing the lift, respectively, with little more than routine maintenance in the intervening years. The measure of all these positive and negative influences on the return is the Internal Rate of Return.
Until relatively recently the calculation of IRR would have been impossible for most investors. Modern bespoke software, and a spreadsheet, make it much easier to calculate.
Does this mean that the gross yield is redundant? No, I don’t think so. A, quick initial appraisal might help to eliminate obvious ‘non-runners’. However, don’t throw the baby out with the bath water. By looking behind the raw figures, and by considering future cash flows, both positive and negative, you can avoid jumping to ‘obvious’ conclusions even if you can’t calculate an accurate IRR. You should see a wider picture which will give you the edge over competing investors, and you might well find that apparently disappointing properties are actually bargains waiting to be grabbed. And, of course, from time to time, you will also find the opposite to be true.
Here’s to successful property investing
Peter Jones B.Sc FRICS
By the way, I’ve rewritten and updated my best selling eBook, The Successful Property Investor’s Strategy Workshop, which is an account of how I put together my multi-property portfolio, starting from scratch and with no money of my own, and how you can do the same. For more details please go to ThePropertyTeacher.co.uk