Unpacking Return on Investment
Return on Investment (ROI) is a formula used to calculate the profitability of an investment, relative to its costs.
I especially love this formula for property because as we’ve already discussed, a smart investor doesn’t use their own money (or at least, as little of it as possible). Therefore, this is a useful formula to calculate the profits on the money you’ve spent.
A property has many expenses, and for this exercise to be accurate, you must include all your non-recoverable expenses. Here are some typical expenses to help get you started:
> Cash input and deposit
> Attorney’s fees (both bond and transferring attorneys)
> Bond registration costs
> Monthly bank fees
> Bond repayments
> Operating costs (including gardening, cleaning, security, service contracts etc.)
> Rates and taxes
> Water, electricity, refuse & sewerage (if not recoverable)
> Any CID (City Improvement District) levies, or the like
> Maintenance & special levies
> Management fees
> Tax (remember to include both property income tax and capital gains tax)
> Any other non-recoverable expenses
Simply put, your gains are your rentals, but include any other income you may generate from the property.
Bear in mind ROI doesn’t consider time. It’s good practice to do this calculation every year, however a great little hack is to divide the ROI by the duration of the investment, which will give you the average annual return.
> You buy a property for R1M, and paid R150,000 of your own money which included a deposit, transfer duty, bond and conveyancing fees.
> The property has a tenant paying R12,000 (ex VAT) per month
The property has the following expenses that are not recovered from the tenant:
> Rates and taxes: R1,000
> Maintenance: R500
> Insurance: R150
> Bond repayments: R8,500
> Total: R10,150
Your NET income is therefore R1,850/month (R12,000 – R10,150)
R22,200 per annum
TIP: Water & electricity are expenses you’d typically recover directly from your tenant, therefore not included in my example. However, your unit may for example be vacant for a month, in which case you’d need to include this cost in your expenses.
ROI = annualised net income divided by cost of investment, expressed as a percentage.
R22,200/R150,000 = 14,8%
Bear in mind, each year your tenant is (hopefully) paying off more of your bond, meaning the value of the equity in your asset increases. It’s also likely the capital value will increase over time. To consider these factors, you will employ the Return on Equity formula, so keep an eye out for this post.
For assistance with your ROI or professional property services, contact Kat.