How to evaluate property investment returns
Most Singaporeans prefer investing in property rather than just stocks and bonds. Renting out property will allow you to generate passive income from collecting rental yield. However, do note that property investment comes with its risk as well. With so many HDB in Singapore , you definitely need to know how to calculate the returns for your property investment before you venture into the property investment bandwagon. This article will guide you through the right ways to evaluate property investment returns.
1- Price appreciation
The simplest way to evaluate the property investment returns is to look at the price appreciation. You have probably heard stories on how someone earn a 50% return by selling their property at $1.5 million after buying it for only $1 million years before.
However, this method of evaluating property investment returns is not the most accurate way to evaluate property investment returns, as it does not take positive and negative cash flows into consideration. These cash flows include rental income collected, and expenses that are spent on the property.
Therefore, the price appreciation method is more suitable for property that you are staying in, and at the same time, expecting a rise in price.
2- Return on investment
Also known as ROI, it is a method that includes the price appreciation by taking the positive and negative cash flows into account. This method will take the collected rental income, the expenses spent related to the property such as rental and purchase transactions, and maintenance fees into account.
Assuming that the property purchase price is $1 million and other relevant costs are $100,000. The returns from this property is assumed at $1.5 million for the property sale price and $4,000 per month for the rental income. If we were to sell this property within one year, the returns will then come up to $500,000 from the price appreciation and $48,000 from the rental income of 12 months. However, there is also a negative cash flow of $100,000 that we will need to take into consideration.
The formula to calculate the return of investment is:
[(sale price + rental income) – (purchase price + other expenses)] / purchase price
If we use the formula above, you will then get a return of 44.8% from the property, which means, you are earning a total amount of $448,000 from a $1 million investment.
Do however note that this method of evaluating property investment return does not take the amount of time spent in investment into account. In addition, it does not take into account of the money that you borrowed to fund your property investment.
3- Cash on cash return
Most property investors will take the maximum property loan when it comes to property investment.The maximum property loan for a residential property is 80% (first property) or 50% (second property). If it is not a residential property, you might be able to get a loan up t0 80% of the property price.
Assuming that you manage to get a 80% loan for the $1 million property investment, you will only need to pay a total of $200,000. From the $100,000, $40,000 is paid in mortgage. $26,000 is for the principle repayment whereas the remaining $14,000 is for the interest payments.
That being said, if you were to sell off the property after 1 year, you will be left with a loan amount of $774,000 to repay. After deducting this amount from the $1.5 million selling price, you will then be left with $726,000 cash.
The cash on cash return method of calculating property investment returns can get trickier as you move into the future as you will have to take additional rents, principle paid to bank during mortgage repayment and other cash used to upkeep the property into consideration.
4- Simple payback period
When you own a property for investment purpose, you will need to determine the duration it takes for your property investment to pay for itself. Most people who invest in property are using this way to reduce the stress of worrying over the price fluctuations.
By the 5th or 6th year, you would most probably have recovered your initial down payment. Many property investors will see the property as paying for itself. By the 20th year, the property price is most likely fully paid regardless of the price of property.
5- Net rental return
Most people look for the possible passive income from renting out their properties. The highlight of having a property for investment purpose is that the return you gain is in the form of the rental yield you get from your tenants.
To evaluate the net rental return , you will need to take the costs involved into account. That being said, you will need to deduct the interest of your mortgage repayment and other expenses that are related to owning your property.
In conclusion, it is important to know the right way to evaluate your property investment returns. Make sure you understand the above property before you jump into the property investment bandwagon. Of course, there are many ways to evaluate your property investment returns. As long as you understand how property investment works, you should be able plan your property investment properly. Do however bear in mind that property investment comes with its risks and disadvantages.