Property Investment
8 min read
Every investor wants a property that gives the “best” return.
Remember, your return is how much you (the investor) make compared to the money you invest.
But there are lots of ways to measure these returns. There is no single “right” way to do it.
Each investment strategy can be successful … depending on how you measure success.
So, the right property for you depends on how you want to run the numbers.
In this article, you’ll learn the 5 most common ways to measure property investment returns. You'll also find out which properties give the highest returns under each measure.
Gross yields are the most common measure property investors throw around. But it's the bluntest tool.
It calculates the rent you get compared to the purchase price.
Here’s how you calculate it:
It's straightforward to calculate. That’s why gross yields are a good first “sense check”.
I use them to figure out if a property is worth looking into before digging deeper.
But gross yields have downsides, too.
Gross yields don’t measure your property's costs (e.g., high body corps or ground rents). So it doesn’t tell you how good your cashflow will be.
It doesn’t measure capital growth, whether you’re paying off debt or renovating to add value. So, it doesn’t consider all your potential returns.
Generally, leasehold properties get the highest gross yields. They are cheap to buy and get decent rents.
But, they’re often not good investments because they don’t hold their value, are hard to sell, and have high costs.
That’s why most investors don’t just care about the gross yield.
For example, a property flipper who buys, renovates and sells doesn’t care about a gross yield.
Gross yields are a way of measuring the rental return. And flippers don’t rent their properties out.
Net yields measure your revenue minus all your costs (e.g. rates, property management). But it doesn’t include your mortgage.
This makes it more sophisticated than a gross yield, but not by much.
The net yield still doesn’t measure cashflow. This is because it doesn't include your mortgage repayments or tax.
Here’s how you calculate it:
Like gross yields, net yields only focus on rental returns. It doesn’t factor in other ways you can make money through property. Things like the house going up in value, renovations, or debt repayments.
Generally, multi-income properties (e.g. home & income) in small towns get high net yields.
But, capital growth may not be as consistent because they are in smaller towns.
John invested in a Christchurch townhouse for $500,000. He rents it out for $500 per week.
That means John gets $26k in rent a year. That’s a gross yield of 5.2%.
( 5.2% = $26k / $500k )
But he's got rates and insurance to pay. All the running costs add to $10k a year.
When John takes that away from the rent, his net yield is 3.2%.
( 3.2% = [ $26k - $10k ] / $500k )
This is the difference between gross and net yields.
When John compares these properties, he uses gross yield to see how the numbers look at first glance.
But John digs deeper to look at a net yield when comparing different properties with different costs.
Next, we get to the cash-on-cash return. This measures the cashflow you get from a property compared to the cash you put into it.
You can also simplify this by just looking at your property’s cashflow.
Unlike gross and net yields, this method measures actual cashflow. That’s the money you either get in your bank account or the money you have to put in to cover all the property’s costs.
But it still leaves out capital growth, gains from renovations and debt repayments.
This method is popular in the US and with commercial transactions. You don't see it used as often in New Zealand.
That’s because many of us aren’t investing much cash into a property. Buy-and-hold investors largely borrow all the money to invest.
On top of that, high interest rates leave most properties negatively-geared. Valocity – a data firm – suggests that only 7% of properties purchased today are cashflow positive (June 2023).
This method could be the right fit for an investor who buys positively-geared properties. It can also be adapted for investors who flip houses and quickly pull their money out.
Generally, property flips give the best cash-on-cash return or properties you buy, renovate, and rent out.
Flippers Sally and Sue decide to buy a property for $1 million.
They put down a $350k deposit and spend $100k renovating the property.
They then sell the property for $1.3 million. After paying their real estate agent, the bank and the tax man, they make a $100k profit.
All up, they put in $450k and made $100k.
That’s a cash-on-cash return of 22%. ( 22% = $100k / $450k ).
My preferred choice when measuring returns is ‘Return on Investment’.
This asks: "For every dollar I invest in a property, how many dollars do I get back?"
It also looks to the future and considers all 4 ways you can make money in property:
This method also takes a longer-term view. It gives you a sense of how well your property might perform over the next 15-20 years.
Then, it compares all these forecast returns to the money you put in over the life of owning the property.
The trouble is, it takes some hefty number crunching. That’s why we created the return-on-investment spreadsheet to handle the number crunching.
It also relies on assumptions to forecast your future returns. This means the exact return on investment will be a bit uncertain. After all, no one can perfectly predict the future.
A lot of the time, New Builds give a better return on investment. That’s because all properties tend to go up in value. But you can buy a New Build with a lower deposit.
That means you get a similar amount of return but for less money put in.
Richard wants to buy his third investment property. It’s a 3-bed, 2-bath townhouse in Auckland. It's on the market for $895k.
It will rent for $750 a week, but Richard would need to top up this property by $200 a week in the first year.
As the years go on, the top-up will likely decrease as interest rates fall and rents rise.
Here’s how the return on investment looks once all the numbers are run on a spreadsheet:
Richard’s property has an estimated return on investment of 364%.
He estimates he’ll get back $3.64 for every dollar he invests. That’s on top of his initial investment.
The internal rate of return is the most advanced and difficult to calculate.
This is the return proper data nerds sometimes use (that’s us).
It estimates your property's annual return over the time you own it.
Like return on investment, this measure includes all the ways you can make money in property.
For example, Jess buys a property for $550k and rents it for $500. Her internal rate of return might be 11.2%.
That means that all the money she puts into her property gives her an average compounding return of 11.2%.
The good thing about this metric is it’s easy to compare against shares and other investments.
Jess sees that banks currently offer 6% on term deposits.
So she sees she can get a 6% return if she puts her money into the bank. Or she can invest in property and get an 11.2% return.
She thinks: “Property is higher risk. But, it’s a better return. So, I will borrow money to put into an investment property.”
But, one of the problems with this method is that you need a spreadsheet to calculate it.
Not only must you forecast your cashflow, but also when you put the money in.
For example, with an off-the-plans New Build, you might put in half your deposit (10%) in year 1.
Then, you put in the other 10% deposit in year 2 when the property is built.
Then, you have to think about when you want to sell and how much you’ll pay the real estate agent when you do. It can become quite complicated.
All these ways of measuring returns can be appropriate, depending on:
I use gross yields when eyeing a new property as a quick sense check. That’s to see whether it’s worth analysing the property further.
Then, I use return on investment to dig deeper.
But, if you only care about cashflow, cash-on-cash return could be a good way of seeing whether you want to invest. This would work for renovations-focused investors, flippers, or commercial property owners.
Property investors often only think of properties as giving high or low returns. That’s the wrong way to think about it.
Sure, a property may give a high or low return … but by what measure?
The real question is: What is the most appropriate way to measure returns for my investment?
Managing Director, 20+ Years' Experience Investing In Property, Author & Host
Andrew Nicol, Managing Director at Opes Partners, is a seasoned financial adviser and property investment expert with 20+ years of experience. With 40 investment properties, he hosts the Property Academy Podcast, co-authored 'Wealth Plan' with Ed Mcknight, and has helped 1,894 Kiwis achieve financial security through property investment.
