Purchasing property, whether with cash or through a home loan, is a significant financial decision.
To avoid overpaying, under-pricing rent, or missing out on a good return when selling, it’s essential to calculate the Return on Investment (ROI) accurately, Remax points out.
Understanding your property’s ROI allows you to assess its profitability and make more informed decisions regarding both current and future investments, the property group says.
Remax explores how to calculate ROI and the factors that play a role in determining it.
ROI is a metric used to assess the profitability of an investment. It compares the total cost of owning the property with the income it generates, presenting the result as a percentage.
Key Considerations in Calculating ROI:
Market Value: The change in property market value (whether it appreciates or depreciates) should be factored in when calculating ROI.
Mortgage Costs: If the property is financed, mortgage repayment costs, including interest, must be included in the calculation.
Below is a table illustrating the ROI comparison for a property purchased with cash versus one financed through a bond.
| Property Cost & Investment | Financed Purchase | Cash Purchase |
|---|---|---|
| Purchase Price | 1,200,000.00 | 1,200,000.00 |
| Additional Costs (Transfer fees, taxes) | 37,371.00 | 37,371.00 |
| Bond Details | ||
| Deposit | 400,000.00 | – |
| Bond Registration | 27,175.00 | – |
| Bond Amount | 800,000.00 | – |
| Term (20 years) | 20 Years (240 months) | – |
| Interest Rate | 11% | – |
| Total Investment | 1,264,546.00 | 1,237,371.00 |
| Annual Income | ||
| Monthly Rental Income | 15,000.00 | 15,000.00 |
| Annual Income | 180,000.00 | 180,000.00 |
| Expenses | ||
| Monthly Expenses (Rates, levies, etc.) | 5,000.00 | 5,000.00 |
| Annual Expenses | 60,000.00 | 60,000.00 |
| Bond Repayment (Principal + Interest) | 8,394.79 x 12 = 100,737.48 | – |
| Total Expenses | 160,737.48 | 60,000.00 |
| Net Annual Return on Investment | 19,262.52 | 120,000.00 |
| Capital Appreciation (Property Value Increase @ 3%) | 36,000.00 | 36,000.00 |
| Total Return on Investment | 55,262.52 | 156,000.00 |
| ROI Calculation | 4.37% | 13.42% |
Financed Purchase: The ROI of 4% is lower due to the costs associated with the mortgage and the bond repayment, reducing the net profit.
Cash Purchase: The ROI of 13% is higher because there are no mortgage repayments, and the return is based entirely on the rental income and capital appreciation.
Key Factors Impacting ROI:
Monthly Income and Costs: The rent charged should cover the property’s ongoing costs, such as rates, insurance, and maintenance.
For financed properties, bond repayments must also be deducted from the rental income.
Emergency Fund: It’s essential to set aside a fund for unforeseen events like repairs or vacancy periods, as household insurance may not cover all costs.
Renting Out a Bonded Property: If the local rental market is competitive, the rent may not be enough to cover the bond repayment, which may require you to supplement the rental income from other sources.
Interest rate fluctuations may also affect the repayment amounts, impacting profitability.
Capital Appreciation (or Depreciation): The property’s market value can appreciate or depreciate over time, which significantly influences ROI.
While this may not immediately affect your cash flow, it impacts your overall net worth and future sale price.
Why is Calculating ROI Important?
Calculating ROI helps ensure you charge competitive rents that generate sufficient income while covering all expenses.
And when selling the property, understanding your ROI gives you critical information about its true value and potential return.
Calculating ROI on a property is essential for understanding its profitability and making informed decisions. Whether you are purchasing with cash or through a loan, the right calculations will help you manage your investment effectively.
