Wednesday, 8 May 2013

Managing your investment - the gross to net effect.

With property investment, people always talk about yield, but what exactly is this? Detailed valuation models will often analyse an initial yield, reversionary yield, equivalent yield or equated yield among others. To most outside of the property industry this will look a bit like double-Dutch and their individual relevance can be subjective. 

Most investors in residential property talk about income yield, which crudely is annual rent divided by price. I say crudely, because often this calculation can be misleading and actually hide a poor performing asset. If you are looking at income yield on a residential property investment, you want the net figure and not the gross. The net figure is derived by subtracting your costs for that specific property (e.g. management, repairs, taxes). Some analysts will argue that you shouldn't include financing (mortgage repayments) but doing so will give you a real idea of performance. 

Not including finance costs, it has been said the average gross to net for residential property investments is 65%. So, based on a gross yield of 5%, your net yield including finance costs will be 3.25%. Now, take into account financing and your returns are further eroded, in some cases income may not cover costs. 

Why would any investor run a negative cash flow? In some countries there can be tax benefits for doing so, but more often than not it is because the investor believes that the price of the property will increase at such a rate whereby the gains from a sale at a point in the future would be significant enough to mitigate a negative cash flow over a period of time. 

This is highly speculative many would argue, and it goes without saying this would only work in a rising market. Essentially, total return of an investment is a combination of income return and capital return (price movements). 

What about if you're a long term investor and not looking to sell anytime in the future?  This is where managing your gross to net becomes important. 

If you have a property manager, make sure they are providing you with value. Property management fees can range from 5% to 20% of the rent received, which can be significant sums of money, so make sure they justify that fee. When undertaking works, sometimes the cheapest option is not necessarily the best and could mean you incur future costs due to poor quality materials or workmanship. Boilers are a good example, cheaper boilers have a shorter shelf life than the more expensive equivalent, therefore over a 5 year period you may spend more on repairs than if you'd gone for the dearer option. 

It's also important to know your competition. Landlords should make sure their property is the best of the competition so void periods are minimised. This is where many investors lose money because they don't spend the time or money on differentiating the quality of their product. Again, know your demand and beware that you don't go overboard, a pig in lipstick is still a pig. 

If you're thinking of investing, often it doesn't hurt to take some advice. Having a plan and knowing your market will prevent nasty surprises but will also ensure you can take advantage of any future opportunities that may present themselves. 

On an unrelated note, look out for our article in this month's editions of the 'Your Media London' luxury lifestyle magazines and our ad in 'The Resident' and 'Mayfair Resident' distributed across London. 

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