Articles

How to Measure Your Property’s Actual Investment Returns?


Investor A or Investor B?

I recently came across two investors who made money in property investing, albeit in very different ways in the last three years i.e. from Mid-2009 till End 2012 in the midst of a property boom period. I have taken the liberty to simplify and change some numbers as well as ignore all expenses so that we can compare apples with apples. Also, I used residential properties for this article as it’s a very much familiar arena to most readers.

There are many different ways to calculate a property investment returns but the Internal Rate of Return (I.R.R) is by far one of the most accurate methods of calculating the cumulative property investment returns over a specific holding period.

Inexperienced property investors and home owners who only look at capital gains as a measure of investment success are always surprised by the difference between the earnings that they expected to realize from a property investment and the actual investment return.

Capital Gains or Growth do not equal investment returns due to many variables like financing, nature of loan amortization and many other costs involved in an entire property transaction process.

How IRR Works

Because a dollar in the hand today is preferable to one a year or five years from now, Internal Rate of Return reveals in mathematical terms what a real estate investor’s initial cash investment from Day 1 will yield based on today’s dollars, not tomorrow’s dollars.

Here are the details: Both properties are located within a 5 minute walk to MRT station and near city.

Note: A financial calculator is needed for I.R.R calculations. (A basic tool for all true blue investors)

Investor A:

Purchased a new launched 916 square feet condo in a matured estate.

Purchase Price (2009): S$930,000

Down-Payment: S$180,000 (20%)

Loan Amount: S$744,000

Upon completion and T.O.P in 2012, he received offers for S$1.2 million.

Equity = S$1,200,000 – S$744,000 = S$456,000

Gross Profits = S$1,200,000 – S$930,000 = S$270,000

I.R.R = 36% per year

Investor B:

Purchased an old 16 year-old 936 square feet apartment in a growth location.

Purchase Price (2009): S$520,000

Down-Payment: S$104,000 (20%)

Loan Amount: S$416,000

Rental Income (3 years): S$2,400 per month

He received offers for S$800,000 in late 2012.

Equity = S$800,000 – S$416,000 = S$384,000

Gross Profits = S$800,000 – S$520,000 = S$280,000

I.R.R = 78% per year

Questions:

1. Who is the smarter or luckier investor in this case?
2. If you were presented with both investment options, which would you go for and why?

My Analysis:

  1. Investor B had similar gross dollar profits with Investor A (S$280k as compared with S$270k) but his actual return on cash invested is 2 times greater than investor A!
  2. Lower down-payment (S$104K for B compare to S$180K for A), but B’s actual return on cash invested is 2 times greater than A.
  3. The returns are higher for B, in terms of cash invested now (down-payment), rental yield now, probably higher returns in future than A’s since B’s property is also located in the growth corridors of Singapore, while A’s property is already in a matured estate.
  4. Similarly, there are higher chances of rental increments due to a growth location and possibly a bigger and stable tenant base for B, and lower vacancy rates.
  5. Investor’s A property is a new property bought directly from a developer, while B’s property is an older re-sale property from an individual seller. One of the arguments I stand firm is that the higher profits that A should have gotten, have already been discounted into the developer’s profit margins and expensive marketing costs.
  6. Investor A’s Day 1 initial cash has zero returns for 3 years until property completion (unless rented after). Investor A is waiting for his returns to materialize 3 years later, while Investor B’s cash is already working hard for him through a strong rental cash flow from DAY 1.

My answer is:

a) Investor B, if the strategy is to hold for rental as well as property value gain. This property will probably give him good rental over the years as it appreciates in value. I would highly recommend this low-risk strategy to the average investor with limited cash resources and seeks safety.

b) Investor A if the strategy is to buy and sell. Reinvest the money again in a similar way but good profits are only as good as a booming economy. And of course, if you sell high, you buy high also. This strategy is speculative and only suitable for an investor with ‘fun’ money.

My opinions:

  • Why plant a seedling if you can plant a tree today? Investor B is already making money from Day 1. Yes!  You can have your cake and eat it too.
  • If I were given 10 such opportunities, I would invest 10 times in B-type of investment scenario. Better rental yield, better capital appreciation, better long-term potential, less risk, less dependent on economy ( good or bad, I still get rental income regardless of property value)
  • For A, maybe for own use or as a gift for loved ones.
  • Investor A has an easier no brainer task – SELL, pocket the profit and look for more deals like this. He thinks making money in property can be as easy as this and will most likely try to replicate the same strategy again. But tomorrow is not today… crazy economies like today don’t always happen.
  • Buying an older re-sale property (Investor B) can have much higher actual returns than simply buying an off-the-plan property (Investor A).
  • B’s property does require a lot more leg work and sweat before the sweetness… but that’s the whole point of it – ‘FUN’!  Its ‘fun’ that makes it all worthwhile for a true blue investor who loves and knows investing!

Conclusion:

Simply taking Rental Yield alone as a benchmark for analysing investment properties is like taking a bow & arrow to a real gun fight!

Understanding and knowing how to calculate Internal Rate of Return (I.R.R) in any of your investments is a crucial skill of an investor.  Measuring your property investment’s actual returns through I.R.R will help you become a more savvy and educated investor in today’s more volatile times.

 

Click Here To Find Out How You Can Harness Your Intentions And Turn Them Into Reality.

Have you benefited from our articles? LIKE us on Facebook to get more benefits.

FOLLOW us on Twitter for our latest news!

 

To your investment success,

Gerald Tay

 

 

 

 


About the Author

Gerald Tay Author, entrepreneur, professional investor and loving father, runs crei-academy.com with a tongue-in-cheek approach to property investment - and himself. He is widely regarded in the industry as 'The Common-Sense' Investor. Gerald writes with passion and straight-forwardness, disclaiming wild claims and impractical investment strategies behind lies and ignorance pervasive in the property industry for vested interests. His well-known statement, "All I did is to value my investments with science, logic and common sense.'

Comments (5)
  • Ryan Lee Jan 22 2013 - 10:05 am Reply

    Hi Gerald

    Very good article. Investment B is always the best as there are rental income and also IRR is double. Agreed that a lot of homework, legwork and negotiation needed too. But payoff is good!

    Just a question on how your IRR is being calculated. I am still learning how IRR could help me.
    For Investment A
    2009, -180,000 (initial 20%) ; 2010, 0; 2011, 0 ; 2012, 270,000 (Gross profit)
    IRR is 14.5%

    For B,
    2009 -104,000
    2010 28800
    2011 28800
    2012 28800+280,000
    IRR = 60%

    Since the above rental income is over simplified, I still could not get your highest IRR 78%; I presume 2400/m is net income.

    Can you show me how you calculate it? I would like to calculate IRR on my investment too.

    Best Regards
    Ryan Lee
    97669133

    • Gerald Tay Jan 22 2013 - 11:21 am Reply

      Hi Ryan,

      I took equity instead of gross profits to calculate, as we still need to pay off the mortgage loan to bank.

      With the rental property (b), it should be in the region of 74-78%. The whole objective is to showcase that a good resale property can be a much better investment than a new property.

      I do teach how to calculate IRR in my workshop, The Smart Property Investor Program. Please apply if you are keen to learn more in detailed.

      Regards,

      Gerald

  • great investing books Jun 12 2013 - 1:48 pm Reply

    Hello, Cool article. Likely to matter as well as your website throughout industry, could possibly go here? Firefox on the other hand is the current market chief and also a huge component to men and women pass over your superb producing for that reason trouble.

  • Damon Mar 9 2017 - 10:31 am Reply

    Hi,

    you do not seem to include interest payments in your IRR calculations. Whilst I agree that B would still be the smarter choice, the IRR would be much reduced as the nett monthly income or PMT would be lower

    • Gerald Tay Mar 9 2017 - 11:02 am Reply

      Hi Damon,

      Both A & B have included interest payments (mortgage + interest/PMT). The IRR includes both.

      A is lower as there are no returns until project TOP.

      B is a better choice as it includes both rental income and sales proceeds.

      gerald

Leave a reply

Name (required)

Website