The quickest way to calculate investment returns

Ever find yourself plugging numbers into an excel sheet to work out your investment returns? It's probably a good idea to have a comprehensive sheet for working out returns on properties you own. What about an easy formula for quick calculations on potential deals?

Here's the quickest way that I've found to calculate cashflow return on investment:



Yield, loan and costs are expressed as percentages of the purchase price or property value. The result of this formula is cashflow return on investment. That is, what return on your initial capital investment you can achieve based on the net cashflow from the property. It does not account for returns arising from capital appreciation.

Yield
No rocket science here, just gross yield. If your property achieves 12,000 in rental income per year and it's valued at 100,000, then your yield is 12%.

Rate
Simply the interest rate payable on your mortgage financing. The calculation assumes an interest only mortgage. If your rate is 5% then that's the number to use.

Loan (or loan-to-value)
This is the amount of your loan, expressed as a percentage of the property value. If you've borrowed 75,000 on a 100,000 property, then your loan is 75%.

Costs
This may be a little different from typical calculations. Here costs are expressed as a percentage of property value. It's actually remarkably simple to calculate. Here's a quick scenario: you pay management fees of 10% of your gross rent, you set aside a further 10% of gross rent as a maintenance budget and you incur further admin costs of 5% of gross rent. In total that's 25% of your gross rent incurred as costs.

Your gross rent is the same as your yield. So if you pay 25% of gross rent as costs and your yield is 12%, then you're paying 12% x 25% = 3.0% of the property value in costs. The great thing about this calculation is that it can remain pretty constant - expressing amounts as percentages means they scale according to property value. Choose numbers that work for you once and you can use the same numbers as a general rule for quick calculations.

Worked example
Here's a quick look at the formula in action. Say you're looking at a potential deal and you want to quickly work out your potential investment returns from the net cashflow it generates. Notice that you do not need to plug in the price into the calcuation (see note below on what this formula should not be used for).

Scenario: a property yields 12%, it can be 75% loan financed at a rate of 5%. Running costs for the property amount to 3.0% (as in the costs example above). What is the cashflow return on investment?

Just plug in the numbers:



And calculate. The answer is 21%.

Without a calculator
You can do this in your head or on paper pretty easily. Loan percentages tend to stay fairly constant and it seems that many investors know ahead of time what percentage they're working with. Rates don't move around all that much, certainly if you're comparing returns across a range of deals at the same point in time, then the rate is likely to be the same for all of them. So, 5% x 75% = 3.75% and dividing by (1 - 75%) is the same as dividing by 25%... or multiplying by four.

The whole formula then becomes: ( 12% - 3.75% - 3% ) x 4 = 5.25% x 4 = 21%. Beats plugging numbers into a spreadsheet to work out return on investment.

What you should not do with this formula
This formula must be kept in context. The fact that the purchase price does not directly appear in the calculations does not mean the price is irrelevant! If you keep all the numbers fixed and double the price, then the formula would show the same return on investment number - this is clearly not true!

The trick is that yield and property price are inversely related. If you double the price then you'll halve your yield - so update the numbers accordingly. This formula should therefore not be used to determine what price you should pay for a property. If you want to try different price scenarios, just remember to adjust the yield and cost numbers accordingly.

What you should do with this formula...
... is take a snapshot of investment performance. The formula answers the question "Taking property price as given, what are my investment returns?".


* Propable has a range of online deal analysis tools that works out all these statistics (and more) for you. Propable is the easiest way to make more money from your property.