Assessing Property Investment – Should I Use Yield or ROCI?


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When looking at your next property investment, it won’t take long before eager Estate Agents ask you the question……”What yield are you looking for ?” But is Yield the right tool to truly assess the potential return of an investment? Rental Yield is usually calculated by taking the annual rental income, divided by the purchase price. For example:
Purchase price: £550,000
Monthly rent: £1,950
Rental Yield: (1,900 * 12) / 550,000 = 4.25%
Nowadays a return of 4.25% might be seen as a potentially attractive proposition compared to Bank Saving accounts for instance. However, it is not that simple. Yield does not take into account a few important aspects such as on going costs related to the property like maintenance, repairs, etc… It also assumed that you are a Cash Buyer. If you finance your purchase with a Buy to Let Mortgage, you might be only putting down 30% as a deposit.
This is why it is highly recommended to use ROCI (Return On Capital Invested) instead when assessing the true potential return of a property investment. See below as an example:
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As the ROCI calculation shown, the actual return on investment is 3.54% not the 4.25% as the Yield suggested. Even more revealing, a slight change of 0.5ppt of the mortgage interest rate will have the following impact: with an interest rate of 4.5% ROCI will become 2.37% and with an interest of 3.5% the ROCI will be 4.70%. Potentially shifting the decision one way or another.
To conclude, if you are buying an investment property with a mortgage, make sure to assess the potential return using ROCI not Yield. It is also important to shop around for mortgage, as small interest rate change might impact greatly the potential property net incomes.
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