June 16, 2019 | 07:45 AM

28.05.2008Measuring the return of an investment property

Renting out an investment property for $700 a week doesn't mean a thing, unless you understand how to calculate your property's yield.

Donal Henahan once cynically observed: "Next to the writer of real estate advertisements, the autobiographer is the most suspect of prose artists."

Strictly speaking, only after an investment property has been finally disposed of does it really become possible to measure objectively just how good an investment it had been. This can then be done by calculating the compound rate of return per annum inherent in the transaction - a figure usually referred to as the "yield" - and comparing this with the returns which alternative investments would have produced.

"Yield" can be defined as "the net rate of interest at which the sum invested equals the present value of all income payments plus the present value of all capital payments."

At the time of acquisition of an asset it is, of course, not possible to calculate with the benefit of hindsight the actual yield which will be achieved over the period during which the asset is held. Thus the optimistic forecasts typically made by estate agents when marketing investment properties need to be viewed with some scepticism.

In an extreme case, as investors in failed companies know only too well, some specific investment might well result in a total loss, even if that possibility looked remote at the time of its acquisition. However, investments are normally entered into on the basis of their prospective or expected yield, calculated on some set of expressed or implied assumptions. In many cases, several different alternative scenarios may be taken into consideration.

The term "yield" is often used more loosely, particularly in the case of shares or property, where it may just represent the expected income over the first year divided by the current market price excluding transaction costs, expressed as a percentage.

The returns from property investments are usually measured in terms of the nominal yield ignoring capital growth and inflation, being the rent per annum divided by the purchase price or the current market value (according to context).

It is really necessary to distinguish between a gross yield (based on the gross rent) and a net yield (based on the net rent after deducting depreciation and any outgo, apart from interest, which is being borne by the landlord). The "outgo" should notionally include an allowance for repairs and maintenance in an average year.

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