Understanding the basics

Appraising the profitability of any potential property correctly is essential. You need to be able to work out if the property you wish to buy is going to leave you with a profit at the end. Over the next few pages I will explain some of the methods used to assess profit or loss on each property.

Gross Rental Yield
The following formula is used to calculate the Gross Rental Yield of a property.

Gross Rental Yield % = (Annual Rent ÷ Property Value) X 100


The Gross Rental Yield is calculated by dividing the annual rent by the property value and is realised by a percentage.

For example
A property worth £90,000 which generates an annual rent of £4,500 will have a gross rental yield of 5%

5% = (£4,500 ÷ £90,000) X 100

The Gross Rental Yield is a good way of comparing similar properties to evaluate the most profitable option. As you can see from the example below, property A is more profitable than property B.

Property A 7.6% = (£6,500 ÷ £85,000) X 100

Property B 3.7% = (£3,500 ÷ £95,000) X 100

Net Rental Yield
The gross rental yield is a good way to make comparisons, however it does not allow for any running costs.

The Net Rental Yield of a property can be a better measure of a properties profitability as it takes into account the running costs.

The following formula is used to calculate the Net Rental Yield.

The example below shows 2 properties with an identical Gross Rental Yield however, when you take into account the running costs, it becomes apparent that property A is more profitable than property B.

Property A 6.9% = ((£6,500 - £600) ÷ £90,000) X 100

Property B 6.9% = ((£6,500 - £1,100) ÷ £85,000) X 100

At this point we have not included the cost of borrowing from a mortgage or any applicable tax, as this is individual to each person.

Gearing
Gearing is a concept used in cases where the buyer uses his or her money to purchase property with a greater value then he or she has at their disposal.

The following illustration is a basic example showing why gearing is so effective in property investment.

Investment via a bank account for a period of 12 months with 5% interest rate.

£12,000 X 5% = £12,600
£600 Gross Profit

Investment via property for a period of 12 months
Capital growth of 5% of £120,000 (NOT £12,000)

£12,000 = 10% Deposit for £120,000 house
£120,000 x 5% = £126,000
£6,000 Gross Profit

The following example outlines the reasoning behind investing monies across several properties as opposed to a single property investment.

Investing £100,000 cash in one property for a period of 12 months .

The net yield of 4% achieved by renting x £100,000 = £4,000
Profit = £4,000
Capital growth of 5% of £100,000 = £5,000

A return of £9,000 on your investment

Investing £100,000 across multiple properties for a period of 12 months

£15,000 deposit across 6 properties with a value of £100,000 each

The yield of 4% achieved by renting X £600,000 (6X£100,000) = £24,000

Profit = £24,000

Capital growth of 5% of £600,000 = £30,000

A return of £54,000 on your investment

Return On Investment (ROI) or Cash-on-Cash Return
ROI reveals the profit you have made over a 12 month period as a percentage of the money you have invested in your property.

This is the formula used to calculate the Return On Investment.

ROI % = (Cash Flow ÷ Cash Invested) X 100

ROI is the percentage of return, cash flow is the gross annual rent minus costs such as void periods, maintenance costs and mortgage repayments. The cash you have invested is the deposit and legal costs paid together with any other fees you may have paid in the purchase.

Loan-To-Value Formula (LTV)
The Loan-To-Value (LTV) is used to work out the ratio between your loan balance and the market value of the property resulting in a percentage.

This formula is used to calculate the Loan-To-Value.

LTV % = (Balance of Loan ÷ Market Value) X 100

For example a property with a market value of £100,000 with a remaining loan balance of £85,000 has a LTV of 85%.

Equity Formula
This is a formula to work out the equity on your property.

Equity £ = Market Value - Balance of Loan

For example a property with a market value of £100,000 with an outstanding loan balance of £85,000 has £15,000 worth of equity.

Rental Cover Formula
Mortgage lenders often need to work out the rental cover of a mortgage to gauge the safety margin for their own risk, the rental from a property will be required to exceed the mortgage payments by approximately 130%. The formula being :-

Rental Cover £ = Monthly Mortgage Payment X 130%

For example: A mortgage application needs to be approved by the lender. With a monthly mortgage repayment of £200, must realise at least £260 rent per month which equals 130% of £200. The rental cover can vary from lender to lender.

More calculators from PublicAngel.com
To help you with your calculations, when evaluating a property for investment, I have created a series of calculators on my website for you to use freely. You will need to register then access the calculators from the control panel.

They are available at http://www.publicangel.com/calculator.php

Gross Rental Yield Calculator
Net Rental Yield Calculator
Return On Investment (ROI) Calculator
Loan To Value Calculator Equity Calculator
Rental Cover Calculator
Loan Calculator
Monthly Rental Calculator (based on loan)
Maximum Loan Calculator (based on rental income)
Calculator from Deposit
Stamp Duty Calculator

Gazumping
When the property market starts to improve and the price of properties rise then so does the unfortunate events surrounding gazumping. The most common practice is evident when the vendor agrees to accept your offer on a property but continues to market the property and then accepts a higher offer, at this point you can consider yourself ‘gazumped’. Regrettably this practice is not illegal, current legislation does not protect the buyer when too many buyers are chasing too few properties and lenders effectively auction the mortgage on the property to the highest bidder.

Gazundering
When the property market has stalled or is in the process of recession immediately prior to exchanging contracts – the buyer suddenly offers a lower price than his or her original offer, knowing the seller is then put in the ambiguous position of not wanting to lose the sale.

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