Analysing the Performance of Your Investment Property
For most of us, the end of the year is a time for reflection and review. While it’s a great time to set personal resolutions for the new year, it’s also the ideal moment to review the year that was. From personal goals through to work achievements, it’s time to take stock before the new year.
If you’re an investor, December is the perfect time to analyse the performance of your investment property. You might feel things are going well, particularly after a tough year, but do you have the numbers to prove it? Do you really know how your property is performing?
As there are several ways to analyse the performance of an investment property, we’ve put together an overview of the main methods used to calculate property performance. Crunching the numbers will help you make informed decisions and help maximise the return on your investment in 2020.
5 Ways to Analyse Property Performance
While some investors are happy to carry a loss (using negative gearing to offset their income), the best measure of property performance is to calculate the profit once you subtract your rental expenses from your rental income. Measuring your cash flow is the easiest way to identify whether your investment property is producing a profit or a loss.
Monthly Rental Income – Monthly Rental Expenses = Cash Flow
When calculating cash flow, don’t forget to include all your rental expenses to ensure an accurate result. Mortgage repayments, insurances, property taxes, management fees, accounting fees, body corporate fees, maintenance costs, utilities and vacancy carrying costs should all be included in your cash flow calculations so you know exactly where you stand.
Return on Investment (ROI)
Calculating your return on investment (ROI) is one of the best ways you can analyse the performance of your rental property. By accounting for everything, including cash flow, equity, and investment costs, you can calculate the annual return on your investment and identify how well your investment is really performing.
(Cash Flow + Principal Payment) x 12 / Total Investment Costs = ROI
Calculate ROI by first measuring your annual return. This is done by adding together your monthly cash flow and monthly principal payment (just the principal, not the interest). Then multiply this amount by 12 to get your annual return. To calculate your ROI, divide your annual return by your total investment costs. Calculating ROI also helps compare returns on multiple properties worth different amounts.
Net Operating Income (NOI)
If you’re looking to compare the performance of several properties, calculating the Net Operating Income (NOI) can help. Similar to the cash flow calculation, NOI calculates the annual income generated by an investment property after subtracting all expenses. However, the NOI calculation does not include principal and interest payments, capital expenditures, depreciation or amortization.
Monthly Rental Income x 12 – Monthly Rental Expenses (less mortgage costs) = NOI
Calculating NOI determines the value and profitability of different income-producing properties, helping you compare the performance of your investments, regardless of how they are financed. Understanding the NOI also aids in determining the capitalisation rate, which is another method of analysing the profit potential of your rental property.
Capitalisation (Cap) Rate
An indicator of profitability, this calculation is used to analyse the return on investment based on the current market value of your property. The capitalisation rate, or cap rate, is a percentage representing the ratio of NOI to the value of your property, indicating the amount of profit you should make each year in comparison to the value of the property.
NOI/Current Market Value x 100 = Cap Rate %
As an example, if you recently bought a property for $1,000,000 with an NOI of $100,000, then the cap rate would be $100,000/$1,000,000 x 100 = 10%. Like NOI, the cap rate does not take into account the method of financing used, instead assuming that the property is unencumbered. As a guide, cap rates are usually 8-12%, although rates can change depending on a property’s location.
Cash on Cash (CoC) Return
The cash-on-cash or CoC return is a percentage representing the ratio of annual cash flow to the total amount of cash invested in a property. The CoC return measures the annual return made on the property in relation to the amount of mortgage paid during the same year. It’s often used to evaluate the cash flow from income-producing assets, with 10% generally considered to be a good CoC return.
NOI/Investment Costs x 100 = CoC Return %
The CoC return value represents the amount of money that you should make each year out of the total amount of cash that you’ve invested in the property, only taking into account the actual cash invested in the property’s purchase. The CoC return percentage will depend on a number of variables, including the property type, location, and rental strategy applicable to your investment property.
After analysing your property’s performance in 2019, you may be looking to increase your return on investment for the new year. Vision Property & Finance is here to help you make the most of your investment and maximise your return. For more information, call 02 8354 3000 to contact our Sydney office or 02 4014 1999 to talk to someone in our Newcastle office. You can also contact us here.