One of the main reasons for making any kind of investment is to build wealth. The goals will vary between investors, but generating returns is generally the basis of an investment. Regardless of which vehicle you choose, it’s important to understand your ROI before committing to ensure that it will generate a positive income flow.
When it comes to real estate, investors may choose this method for a number of reasons such as its passive and steady income prospects and portfolio diversification opportunities. No matter your motivation or end goal, it’s essential to be able to calculate your potential returns on a property to establish its profitability.
What is ROI and how is it calculated?
A return on investment (ROI) lets you know how much profit is made on the initial invested sum. In other words, how much more money has been made since the original cost. This is usually presented as a percentage figure. The basic formula for calculating ROI is:
For instance, if you purchase a share in a property company for £1,000 and sell it for £1,600, that’s a net profit of £600, making the ROI 60%.
However, assessing ROI isn’t always so straight-forward. Residential property investments are slightly more complicated as there are additional costs to think about, all of which will affect the final number. ROI in Buy-to-Let (BTL) properties is often expressed as rental yield, and the formula for this is:
Rental income is determined by subtracting running costs from the rent total. Some of the running costs involved in a BTL property can include:
- Deposit (usually 20-40% is required for a BTL mortgage, plus an extra 3% if you already own another property. This also applies to stamp duty)
- Stamp duty (up to 15% depending on the property price)
- Refurbishment/maintenance costs
- Legal fees
- Survey costs
- Letting and management costs
- Mortgage repayments
Each of the above factors is subjective and dependent on your financial goals. Letting fees, for example, may not apply if you are able to manage the property yourself, which can reduce costs significantly. However, if you’re looking for a hands-off approach, working with a letting agent could be a justified expense if you value the convenience of third-party management, which can help with saving you time and energy. Remember: this is a competitive market, so it’s useful to compare quotes for these types of services and fees are negotiable, which opens up some cost-cutting solutions.
Estate agents Preston and Barker’s online BTL investment calculator can help with assessing investment opportunities by entering the property asking price and adjusting each section to your own financial requirements. A couple of things to bear in mind are that these are pre-tax calculations and, if you don’t yet own the property or have tenants, evaluating your ROI will be difficult and it will only be an estimate.
It’s also important to remember capital growth potential when considering a property investment. While the initial or regular outgoings can be high, there is an added benefit of the value of the property increasing over time, which could be particularly advantageous when it’s time to sell. However, this isn’t guaranteed and shouldn’t be based on previous market trends as a property value will increase or decrease depending on the current market conditions.
Why is ROI important?
Understanding the profitability of a real estate investment is crucial to be able to make an informed investment decision. Before committing, it’s a good idea to be aware of the costs and regular expenses involved, as well as the rental income you expect. This will allow you to draw comparisons to other properties or investment methods. Once these boxes have been ticked, you can then build a clearer picture of your likely ROI and determine whether that meets your financial goals.
What makes a ‘good’ ROI?
Establishing the profitability of a property depends on several factors such the initial cost, property type, and location. A BTL property, for example, can typically generate approximately 5-7% ROI, while a house of multiple occupancies (HMO) could offer more at around 15-20% as the renting of individual rooms adds extra revenue flow. Another example is investing in a property development, which involves buying a property that requires renovation to increase its value. Short-term, the costs will be higher as there are more expenses to cover such as electricity and plumbing installation, but long-term, the refurbishment will add to the value of the property, which could increase its ROI.
A key variable which can affect ROI is the location.
The above map displays property yield hotspots across the UK. With the average annual rental value increase of 8.5%, darker areas above such as Scotland, Wales, and the midlands can offer better yields due to lower house prices, while areas such as London and the southeast can have much lower yield prospects and, therefore, lower ROI potential as house prices are considerably higher.
Another key contributing factor is the property type. Recent trends published by the Office of National Statistics show how UK property prices have changed over the course of one year across 4 types of residential housing.
Detached properties have experienced the steepest price increase from 8.8% in January to 15.3% in December 2021, followed by semi-detached houses (+3%), terraced houses (+1.3%), and flats and maisonettes (+0.9%). Depending on which property type and size you purchase, this will influence your ROI as the initial cost involved with a detached house will be higher than, for example, a terraced home.
The key message is that profitability is based on a variety of factors, all of which will affect the ROI, and what is deemed as a ‘good’ ROI will largely depend on your investment goals. Whatever those goals may be, it’s always advised to consult a mortgage broker or financial professional, who will be able to help with aspects such as mortgage affordability before buying a property.
Other ways to generate returns through property investing
At Propiteer Capital, we fund a varied property portfolio across 5 assets classes, including residential homes, rental apartments, and commercial buildings. We offer hands-off property investment opportunities with products across three main categories: Residential Rentals, Branded Hotels, and Development Properties, offering an annual ROI of 5.0-7.5%.
Comparing this to a traditional BTL, an example property with an asking price of £200,000 and a monthly rental income of £800 would generate a rental yield of 4.8%. For a direct property investment, this is a strong result. However, our investment products offer the added value of a convenient, hands-off approach to property investing and require considerably lower initial funds. Meanwhile, a traditional BTL would require extra time and effort from start to finish, including sourcing property, securing a mortgage, and finding tenants.
- The basic formula for calculating ROI in property is to divide the net profit by the original cost or investment value.
- When it comes to BTLs, various upfront costs and running fees need to be deducted before reaching your ROI percentage, but there are cost-cutting solutions available.
- With traditional BTLs, rental yield can depend on location and property type. The higher the yield, the better.
- The profitability of a property investment is determined by individual financial goals.
- Propiteer Capital offers a passive property investment approach via asset-backed listed bonds with rate annual returns of up to 7.5%.
To find out more about our investment methods or to learn more about Propiteer Capital, visit our website.
Rates are accurate at the date of publishing. For our latest rates, please visit our homepage.
Recommended Read: Commercial Property is a Great Investment. Here’s Why.