CALCULATING RETURN OF INVESTMENT (ROI) ON A RENTAL PROPERTY

How do you calculate your investment returns?

The process of calculating property investment returns can be very complicated indeed. On commercial property investors will go to great lengths to use techniques which discount future cash flows from individual investments to work out the potential returns and in turn their value.

For residential property owners life doesn’t need to be so complicated. The focus for calculating potential returns on property should be on the two main factors.

Firstly the income such as rent, and secondly, the capital appreciation resulting from the potential rise in property's price. An investors total returns are the sum of both.

Returns from a rental property

Buying a residential investment property is not just like buying a straight forward investment. An investor is actually perceived as running a business, and therefore needs to include any associated costs of running that business in their calculations.

The standard costs are categorised as: mortgage (if any), maintenance, building administration, property management, property taxes, vacancy period, and cleaning. Rent and other costs are likely to change over the investment period and this needs to be factored into the calculation of a landlords investment returns.

The main revenue source is obviously the rental income, so when calculating their net returns a property owner needs to include net income (after expenses) and add this to capital appreciation. This needs to be done for the entirety of the investment period.

Buying & selling costs

Buying a residential investment property will mean that an owner incurs certain set up costs for bringing the investment into being. These costs include the initial costs involved in the purchase of the investment property such as the legal fees. Finally, there is the cost of exiting the investment when selling the property in Panama around 10% of the closing price (5% taxes, 5% broker commission). All these need to be factored into the overall calculation of a property investors returns.

Accounting for the long-term

One further complication to a property investor trying to calculate their likely returns is trying to account for the effect of inflate on and the likely growth rate in house prices generally. Therefore in calculating a residential investment’s long term returns a landlord will need to be able to predict both of these.

The return on capital

These calculations of returns all relate to the asset value of the investment property and the rental profit after expenses. However, this is not a true measure of the real returns made by a property investor. This is because unlike a deposit in an investment fund or government bonds a property owner is likely to have borrowed a significant proportion of their investment capital in the form of a mortgage. This means that they are likely to only have put in a proportion of the total capital into the investment. For example on a $300,000 property they may have put down a 30% deposit or $90,000 into the investment. What this means is that any investment calculations needs to measure what the returns are on that $90,000 and any other additional capital costs not just the $300,000 in order to enable a potential property investor to measure whether the returns are good and likely to be better than investing that money in alternatives such as investment funds or government bonds.

What returns should you be aiming from a property investment?

To some extent the investment returns required will depend on each individual circumstances. For some investors anything above that available on government bonds deposit account would be OK. This type of return generally is not that high as it reflects the fact that it is a low risk investment. Property investment is not risk free and given that an individual is investing a considerable amount of time, effort and capital it is reasonable to expect a return above this.

A property developer would look to receive a return of about 20 - 25% on capital invested. However, carrying out a development is far more risky than an investment. In addition, a development particularly a large one is likely to take place over several years; in which case the annualised returns could easily be halved to say 10%.

If we use these figures as a guide I would say that a long term real return of between 6-10% is OK although not excellent. An investor has to appreciate that buying a property investment is not passive in the same way as holding government bonds is and running a rental business does involve small amounts of work to keep it on track. Therefore the returns that a property owner should expect from their investment should reflect this. A landlord should be aiming for at least a high single figure and preferably a double figure return on their capital. Anything above 20% is excellent.

The difficulty with predicting property investment returns

Long-term predictions are notoriously difficult. Predicting things like the interest rate, the levels of inflation further out than a couple of years into the future was impossible up until recently. Hopefully the Panamanian housing market will continue to benefit from this stable investment environment and enable all your property investments to continue to prosper.

Contact Us:
Panama Link Property Management
Phone: (507) 392-5918
Address: Oficina 1801, Piso 18 - Grand Bay Tower Avenida Balboa – Edificio UniBank
Email: info@panamalinkpm.com
Website: https://panamalinkpm.com