Discover how to calculate if a property is a good investment. Learn how to know if a property offers the right value for money in our guide to real estate ROI.
Real estate is a popular investment choice for many people, especially those with extra capital who want a guaranteed investment return. However, it can be challenging for those just getting started to keep track of all the facts and figures when evaluating potential properties.
So, how do you know if you’re making the right real estate investment choice?
Fortunately, there’s a metric that can help you determine quickly and easily if an investment property is worth considering. That metric is known as Return on Investment (ROI), and computing it is how to calculate if a property is a good investment.
At Yield Investing, we pride ourselves on offering some of the most ethical investment opportunities in the UK, such as high-yielding buy-to-let housing developments with social housing contracts. However, before you invest, let’s help you understand how ROI works in the first place and how to calculate if a specific property is a good investment using this metric.
What is Property Return on Investment (ROI)?
If you’re considering investing in real estate, you may have heard the term “Return on Investment” or ROI. This measures the potential profitability of property investment.
To calculate a property’s ROI, you need to know the following:
- The initial costs of purchasing and owning the property, such as:
- Purchase price
- Taxes
- Legal fees
- Initial repairs or renovations
- Ongoing expenses:
- Property management fees
- Utilities (if included in the rent)
- Insurance
- Potential returns on the property, which can come from:
- Monthly rent charges
- Income from ancillary services like laundry or parking fees
- Capital appreciation over time
Once you are clear on all these figures, you can calculate the ROI on a property to see if it’s a good investment.
Calculating Investment Property Returns: How to Calculate ROI
To calculate the ROI, the formula is as follows:
ROI = [(Gain on Property – Cost of Property) / Cost of Property] x 100%
Here’s an example to explain how to break down the formula into “real figures”.
If you purchase a rental property for £100,000 and sell it for £140,000 after five years, and you have a cash flow of £7,000 per year, then the gain on the investment is £175,000 (£40,000 from the selling price increase, £35,000 from the cash flow, and £100,000 from the initial investment).
The ROI on a Cash Purchase = [(£175,000 – £100,000) / £100,000] x 100% = 75%.
The cash-on-cash return of the rental property can also be calculated using the following formula:
Cash-on-Cash ROI = [Annual Before-Tax Cash Flow / Total Cash Invested] x 100%
Using the above example, the cash-on-cash ROI = £7,000 / £100,000 x 100% = 7%.
What is a Good ROI in Property Investment?
A “good” ROI in real estate is subjective and can vary depending on:
- The location
- Market conditions
- Your investment strategy
- Your personal goals
However, the average annual ROI for residential real estate is presently around 10%, so anything above that is better than average.
How to Calculate Long-Term ROI on Properties in the UK
When you’re determining whether a property is a good investment, looking at long-term ROI helps you understand the true value of your investment over time rather than just the immediate returns. In the UK, you can work out long-term ROI on properties in several ways using any of the following metrics.
House Price Index (HPI)
HPI is a tool that helps investors determine potential returns by identifying areas where house prices have increased or decreased. This can help investors decide which properties will likely bring substantial returns. For example, the UK government website provides HPI data that investors can use to evaluate the long-term ROI of a property.
Property Value Estimators
Using property value estimators is another way to understand potential future ROI on property investment. These are widely available online and often provided by estate agents, property portals and banks. Property value estimators can provide calculations based on current market conditions, such as:
- Sales prices of similar properties in the same area
- Any estimated increase or decrease in the value of the property in question over time
Rental Yields
Rental yield calculators take into account factors such as:
- Market rent for similar properties
- Length of the tenancy agreement
- Any maintenance or upkeep costs
For investors seeking high-yield property investments, this rental yield calculation should give you an idea of how much money you could make from monthly rental revenue. This is an essential tool if you’re looking for long-term ROI from your investments.
The long-term ROI gives you the full picture of a property’s potential. With these tools in your pocket, you’ll know exactly what returns to expect, helping you spot the best real estate investing opportunities while avoiding costly mistakes.
How to Calculate Return on Investment for a Rental Property
Calculating the ROI for rental properties in the UK for cash transactions involves comparing the yearly net income generated by the property to the total money (in cash) invested in the property.
This metric can be calculated using the following formula:
ROI = [Net Annual Rental Income / Total Property Cost] x 100%
Where:
Net Annual Rental Income = Gross Annual Rental Income – Annual Property Expenses
Total Property Cost = Purchase Price + Acquisition Costs + Renovation Costs
Step #1: Calculate the Gross Annual Rental Income (GARI)
The gross rental income (GRI) is the total rent you receive from your tenants in a year.
For example, if you own a rental property that generates £1,000 per month, the gross rental income for the year would be £12,000.
Step #2: Calculate the Annual Property Expenses
These are the costs associated with owning and managing the rental property, including:
- Property taxes
- Insurance
- Repairs
- Maintenance
- Property management fees
- Other expenses
For example, if your property has an annual property tax of £1,000, an insurance premium of £500, and a property management fee of £1,200, the total expenses would be £2,700.
Step #3: Calculate the Net Annual Rental Income (NARI)
This is the gross annual rental income (GARI) minus the annual expenses of owning and managing the rental property. It’s also known as net rental income (NRI) or net operating income (NOI).
Using the examples above, we can calculate the net annual rental income as follows:
Net Annual Rental Income = Gross Rental Income – Annual Property Expenses
Net Annual Rental Income = £12,000 – £2,700
Net Annual Rental Income = £9,300
Total Property Cost = This is the total amount of money invested in the rental property, including:
- The purchase price
- Acquisition costs, like legal fees, stamp duty and renovation costs (if any)
For example, if you purchased a rental property for £200,000, paid £5,000 in acquisition costs and £10,000 in renovation costs, the total property cost would be £215,000.
Step #4: Calculate the ROI
This is the percentage return on investment you can expect from your rental property.
Using the examples above, we can calculate the ROI as:
ROI = [Net Annual Rental Income / Total Property Cost] x 100%
ROI = [£9,300 / £215,000] x 100%
ROI = 4.33%
In this example, the ROI for the rental property is 4.33%. This means that for every £1 invested in the property, you can expect a return of £0.0433 per year.
Note:
- The ROI calculation doesn’t factor in potential changes in property values over time, which can significantly impact the overall return on investment.
- You should also think about the risks associated with owning and managing rental properties, such as:
- Changes in rental demand
- Unexpected repairs and maintenance costs
- Tenant turnover
However, if you invest in our risk-free assets, you don’t need to account for damages and maintenance and are sure of a constant tenant turnover. This will increase your ROI and result in more yearly gains. Our development projects in the social housing sector offer uniquely stable returns due to consistent demand and government backing. Social housing investment risks are low due to guaranteed occupancy and structured maintenance.
Other Considerations When Calculating Property ROI
When deciding whether housing is a good investment in the UK, you must consider factors beyond the initial ROI calculation.
Location
Location directly impacts your returns, with the best housing prices in the UK often found in unexpected areas. While London once dominated the market, regions like the North East now offer the highest yields in the UK, thanks to strong rental demand and more affordable entry prices.
North East property investments are particularly attractive, as these areas combine lower purchase costs with high tenant demand – a perfect recipe for strong returns whether you’re looking to rent or sell.
Tax Considerations
Tax implications for investors can significantly affect your total investment returns. When purchasing property, you’ll need to account for capital gains tax (CGT) and other property-related taxes. Understanding these obligations upfront helps you assess a property’s true profit potential and avoid unexpected costs that could eat into your returns.
Holding Costs
The property holding costs, such as repairs and maintenance, must be factored in when working out ROI. These can vary depending on the type of property purchased and its age. It’s essential to account for these holding costs when calculating ROI to have a realistic idea of the total return you will receive from the investment.
3 Key Property Investment Calculation Metrics
When considering investing in property, you can use several calculations to determine whether it’s a wise investment.
Gross Rental Yield (GRY)
This metric divides the property’s annual return on rental income by the purchase price.
Gross Rental Yield = [Annual Rental Income / Cost of Investment] x 100%
A desirable return for a real estate investor in the UK should be 8–10%.
Net Rental Yield (NRY)
This metric divides the property’s annual rent income, minus any fees associated with renting out the property, from the annual rental income (such as maintenance costs, mortgage payments, and agent fees) by the purchase price.
Net Rental Yield = [(Annual Rental Income – Annual Property Expenses) / Cost of Investment] x 100%
This provides a more realistic assessment of your ROI on that specific financial commitment.
Capital Growth (CG)
The capital growth metric evaluates how much your invested capital has increased over time. This is determined by looking at how much a property has increased in value since you bought it initially and subtracting inflation from that number to get an accurate figure of how much financial benefit you’d be getting out of that specific asset over time.
How to Calculate If a Property Is a Good Investment
Let’s use an example to explain the above three metrics:
If you purchase a property for £250,000 and earn £25,000 annually in rental income, your Gross Rental Yield is 10%.
GRY = [£25,000 / £250,000] x 100% = 10%
However, if you deduct £5,000 in fees from the income, your Net Rental Yield becomes 8%.
NRY = [(£25,000 – £5,000) / £250,000] x 100% = [£20,000 / £250,000] = 8%
If the property appreciates by 2% over time and inflation is 1%, your Capital Growth will be 1%.
CG = 2% – 1% = 1%
These calculations can help you make informed decisions and determine whether a property investment is worthwhile.
How Rental Properties Differ From Other Real Estate Investments
Before you invest in buy-to-let properties, it’s essential to understand that rental properties differ from other investments. In most cases, rental properties are best suited for long-term growth and more advantageous than short-term investments.
This is because rental properties typically produce a steady income that can be used to pay down the mortgage, offset other costs associated with maintaining the property, and even allow for some additional profits.
There are a few things to look into when considering rental properties as an investment, including:
- The property’s condition and any upgrades you may need to make before it’s ready for tenants.
- Any additional costs, such as taxes and insurance, due on the property.
- The potential tenant pool and if it will be easy to attract suitable tenants
For example, a property close to public transport links or amenities will likely have more appeal than one in a remote area:
- The local market and factors such as:
- Housing market volatility
- Population growth or decline
- Job market trends
These can affect a property’s potential to accrue an attractive return on the initial investment.
By understanding the local markets and considering all costs when purchasing a rental property, investors can benefit from long-term returns that outpace those seen with stocks or bonds over time.
How Do You Determine If a Property Is a Good Investment?
One widespread formula to help you determine if a property is the right investment for you is the 1% rule. This rule typically suggests that the property’s monthly rent shouldn’t be less than 1 per cent of the initial cost after factoring in any preliminary repairs and property costs.
To illustrate, a property costing £100,000 should have a minimum monthly rent of £1,000.
However, it’s important to do further research and analysis to determine if a house is a good investment:
- Location
- Market trends
- Potential annual rent
- The property’s condition
- The investment’s overall cost
For example, if you buy an investment property that needs a lot of repairs or work carried out before you can rent it out, these costs need to be incorporated into your ROI calculations to ensure they will be covered without impacting your profits.
How to Calculate the Value of Property: 3 Factors to Consider
If you’re considering investing in rental property in the UK, it’s essential to understand the potential returns on your investment. To do this, you need to know how a property is valued.
The Royal Institution of Chartered Surveyors (RICS) provides detailed guidelines for property valuation, which involves looking at three main factors:
Comparable Sales in the Area
This refers to recent sales of similar properties in the surrounding area. This information provides insight into the current market value of the evaluated property.
The Condition of the Property
This includes any needed repairs or improvements. Surveyors will examine the property’s overall condition, including the structure, plumbing, and electrical systems, and any cosmetic updates it may require.
The Rental Income
Surveyors will examine the current rental income and compare it to similar properties to determine if it’s reasonable. The rental income estimates the potential return on investment for the property.
The Capitalisation Rate (CP) Calculation
Surveyors can determine the fair sale price for a unit by working backwards from comparable sales and factoring in condition and rental income. This calculation is known as the capitalisation rate or cap rate (CR), and it’s an important tool for assessing whether an investment will deliver solid returns.
Capitalisation Rate = [Net Operating or Rental Income / Current Market Value of the Property] x 100%
So, for a property whose annual rental income is £30,000 and currently valued at £300,000, the cap rate is 10%.
CR = [£30,000 / £300,000] x 100% = 10%
How Yield Investing Can Help
At Yield Investing, we specialise in ethical property investments in the UK, like social housing and supported living, in prime locations such as Durham, Middlesbrough, Hartlepool and Yorkshire.
As an investor, this means you have secured yearly rent income with other benefits such as damage or maintenance cover and free property management. Our tenants treat the housing associations as landlords rather than reporting directly to you, which makes this an easy, hands-free investment for your property portfolio.
We offer various investment options, including individual flats in blocks, fully freehold blocks, large HMOs/bedsits, and family rentals. These options are top-rated among overseas clients who seek to purchase prime UK real estate with tenants and a management company already in place, providing a steady yield with solid growth potential.
As a reputable developer, we consistently deliver high-quality properties that we are confident will interest our clients. Our track record speaks for itself. By investing with us, you can benefit from long-term leases, strong tenant covenants, and high net returns. Don’t miss out on this opportunity to invest confidently and earn a steady interest, and contact us today!
