All Topics / Finance / Top 5 financial criteria’s to evaluate a rental property investment?

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  • Profile photo of InvestorTOTORInvestorTOTOR
    Participant
    @david-de-mezin
    Join Date: 2014
    Post Count: 16

    A – Will you agree that the 5 following financial criteria’s are the best to evaluate a rental proprety investment?
    1) GRR,
    2) ROI,
    3) CoCR,
    4) GoER,
    5) NPP.

    B – What will be the minimum % for each criteria to consider them as a good result?

    Profile photo of InvestorTOTORInvestorTOTOR
    Participant
    @david-de-mezin
    Join Date: 2014
    Post Count: 16

    Looks too difficult to answer!

    Profile photo of StannisStannis
    Participant
    @ben-stanton0
    Join Date: 2015
    Post Count: 23

    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

    Profile photo of InvestorTOTORInvestorTOTOR
    Participant
    @david-de-mezin
    Join Date: 2014
    Post Count: 16

    Hi Ben,
    Thank you for your message and showing interrest on my post.
    I was trying to blend-in with the seasonal investors posts by using acronyms…
    Anyways, here are the meaning behind theses acronyms.
    1) Gross Rental Return (GRR)
    GRR=(Annual Rent/Purchase Price) x 100

    2) Return On Investment (ROI)
    ROI=(Annual Profit/Purchase Price) x 100

    3) Cash-On-Cash Return (CoCR)
    CoCR=(Cash Back/Cash Down) x 100

    4) Growth On Equity Return (GoER)
    GoER=(Expected Annual Growth/Current Equity) x 100

    5) Net Profit Percentage (NPP)
    NPP= [(Annual Cash Flow + Annual Expected Growth)/Cash Down] x 100

    So, what are the acceptable % to reach for each crieteria to be considered as good.
    Thank you for yoru feedback

    Profile photo of StannisStannis
    Participant
    @ben-stanton0
    Join Date: 2015
    Post Count: 23

    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 ago by Profile photo of Stannis Stannis.
    Profile photo of InvestorTOTORInvestorTOTOR
    Participant
    @david-de-mezin
    Join Date: 2014
    Post Count: 16

    Ben,
    Thank you for this extensive and informative answer.
    It is clear that, when it comes to evaluating an IP, you are using different criteria’s!
    I thought I coudl get a simple answer on a quite complicated question or group of questions but it is more complex than that as you mention it:”it depends on your investment strategy”!
    Cheers

    Profile photo of CattleyaCattleya
    Participant
    @cattleya
    Join Date: 2008
    Post Count: 121

    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

    Cattleya

    Here to learn the ropes of property investing & share knowledge, not trying to sell anything at all.

    Profile photo of Don NicolussiDon Nicolussi
    Participant
    @don
    Join Date: 2005
    Post Count: 1,086

    As always I try to keep things simple in my own head.

    Start with:

    What is the idea behind buying the property. Will it grow in value and why. What has your personal reading a research told you.

    Then:

    Is money coming in each month greater than money going out pre tax.

    If not – what is happening after tax.

    If still cash flow negative how long will it be in years before the property is neutral or paying for itself based in growth in rental income.

    Then:

    How much of your available capital (potential money to invest) is being used up.

    Then:

    How will buying it get you closer to your financial goal.

    Don Nicolussi | Mortgage Broker - Home Loan Warehouse
    http://homeloanwarehouse.com.au
    Email Me | Phone Me

    "I think of finance as a technology, a way of getting things done." Robert Shiller

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