How to Calculate ROI for Your Investment Property

When it comes to an investment of any kind, it’s important that you know the rough return on investment (ROI) you can expect from it. But while the formulas used to calculate these percentages for property investment look simple on the surface, in reality, you need to take into account a variety of different factors that can add or subtract from this number.

Today we’ll provide a very simplified guide to estimating your potential ROI from a buy-to-let investment, but it’s important to keep in mind this will simply be a ballpark figure, and in order to get a more accurate prediction, it’s important to talk to a property investment manager. With that out of the way, let’s get started.

The basic formula for calculating ROI

Your ROI is simply the profit you may expect from your investment, expressed in terms of percentage of your original investment. The basic formula for calculating ROI is as follows:  you take the net profit of your investment and divide it by the original cost of acquiring it. Of course, things are not quite as straightforward as that, and many other factors will affect this number, such as your mortgage repayments, vacancy periods as well as repairs and maintenance costs.

How your mortgage affects your ROI

One of the things that will affect your ROI percentage is whether you buy your investment property in cash or with the help of a mortgage. Say you buy a property for £250,000 in cash and can expect a monthly rental income of £800 per month. In a year, your ROI from rent alone will be 3.8%. 

Now consider a scenario where you buy that same property for £250,000 but do so with the help of a mortgage, paying £50,000 upfront. Not taking into account your mortgage repayments, your ROI will be 19.2%. 

So it’s easy to see how taking out a mortgage rather than paying for your buy-to-let property cash in hand boosts your ROI – though you’ll have more money in hand at the end of the year if you’ve bought your property outright as mortgage repayments won’t have retracted from that sum. This is why we almost always recommend our property investment clients take out an interest-only mortgage – this will boost your ROI and actual profits much more.

However, when it comes time to sell your property on, if you bought it in cash, you get to keep virtually all the money, while if you took out a mortgage, a large sum will go towards paying that off. So at the point of sale, if you bought your investment property outright, you’ll likely end up with a slightly better ROI after all, as you’ll not have paid fees or interest on a mortgage. We did tell you this would get complicated!

Not to mention that spreading the sum you’re wanting to invest across two or more properties will boost your monthly rental income, and thus your ROI. So investing in two properties with the aid of mortgages will often be a better idea than buying just one outright – though which option is right for you will depend on your investment goals. You can read more about this subject in this blog post.

Why ROI isn’t the same as profit

Of course, the above calculations don’t take into account the many ongoing costs of buying and owning investment properties, like your LBTT, closing fees for the sale as well as repairs and replacements to plumbing, electricals and furniture. And if you struggle to find tenants for your property for a prolonged period, this will naturally eat away at your profits.

So it’s clear that ROI and profit are not the same. While your ROI is an estimate, profit is the actual cash you’ll have in hand at the end of a certain period of time. 

Like we already mentioned, not taking mortgage repayments into account, you have the same amount of rental income in hand at the end of the year whether you buy your property outright or do so with the help of a mortgage even if the ROI percentages for these two scenarios are wildly different.

At the end of the day, the equity you have in your investment property and the demand a property like yours is at the time you sell it will determine the true return on your investment.

Equity & ROI

Your equity is the market value of your property minus the total loan amount still to be paid. So the more of your mortgage you pay back, the more equity you have. To add this to your ROI, you simply need to calculate how much you’ll pay back to your lender in a year, taking into account how much of your payments go towards actually paying off your mortgage. This number can be found in your mortgage amortisation schedule.

And as property prices in Scotland have been trending upwards for many years now, the money you get out of your investment at the point of sale will likely only grow the longer you own your investment property. 

Of course, this money will only become available once you sell your property, and it’s impossible to know exactly how much your property will sell for. Additionally, selling property always comes with its own expenses. However, if you’ve been able to source an investment property in an up-and-coming neighbourhood and it’s the kind of home many people are after, you could get a very good return on your initial investment when it comes time to sell. 

ROI vs. rental yield

You’ll often hear about the average rental yields of a neighbourhood, and this is an important part of your ROI calculation. However, the two are not the same thing. Simply put, you get your rental yield percentage by dividing the property’s expected or actual rental income by the initial cost of buying the property. ROI, on the other hand, will also take into account equity you’re building and capital growth in terms of your property’s rise in value.

Here at Cox & Co, we warn our investors not to place too much value on estimated rental yields, and this is due to many of the reasons already mentioned in this article: this number can easily be manipulated by what’s taken into account: void periods, repairs and maintenance costs and fees involved with buying and selling property will all have their impact on how much money you actually get to take home.

The bottom line

Calculating ROI for a residential property can be very tricky, and the percentage is easily manipulated depending on what you include and exclude from the formula. It doesn’t help that there are property investment professionals out there who take full advantage of this fact in order to make a property they’re selling appear more profitable.That’s why having someone in your corner who can cut through the noise and help you get a better idea of the true financial value of a potential investment is so important. This is exactly what we can offer here at Cox & Co. We’ve spent years perfecting our turnkey service for property investors, offering support for every step of the way, from property sourcing to buy-to-let mortgages to lettings. Find out more about what we do on our property investment service page.

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