Property investment is one of the biggest decisions that we take. It requires a significant amount of capital and is usually a long-term commitment, if you plan to turn it into a lucrative enterprise. There may be exceptions though. Investment in property gives you a long-term financial security. So with so many options available all around you, which property would put your money on?
Cash flow, in simple terms is the profit left over from the rental after cutting out all the expenses. Say you rent out the property for 1000 AED and you have spent 600 AED for repairs, bills and other expenditures. This brings cash-flow to a total of 400 AED. This is the most direct and apparent way to measure your earnings from a rental property. This gives you data on the potential of the investment and how fruitful or futile it is becoming as the time passes.
The 50% Rule
This is the rule of thumb to ensure that your property investment is not going down the drain. Ideally, all your non-mortgage expenses should average out below 50% of the rent. Calculating this may a little trickier as compared to cash flow. The 50% strategy is to ensure that you have a long-running account that can cover for all your planned and unplanned expenses on the property. To put it simply, if the rent you get is 1000 AED and your monthly mortgage comes around 200 AED, than you add that to 50% of rent i.e. 500 AED and subtract that from your rental amount. Doing this you get 300 AED, which would be your monthly cash-flow. Though, this seems like a minimal amount and 50% might seem like an over estimation. But take all the big and small expenses annually into account and you would find the stats matching the theory. Hence, put your mind at ease and leave that half aside for the property maintenance. Although, if the expenses frequently go above 50%, it means you may be suffering loss on the property as per market standards, despite have a regular cash-flow.
Return on Investment
Measuring RoI is rather simple. If a 1000 AED investment results in 100 AED profit over a period of one year than we have RoI of 10%. It is a simple calculation of money put in and money received. As per the previous example, we are putting in 200 in mortgage per month, which amounts to 2,400 AED per year. Against it, we receive 300 AED per month in cash flow; that would be 3,600 AED per year. Add the down payment to this, let’s say 28,000 AED. So our RoI would be 28,000/2,400 = 11.6% returns each year. This is the amount that you receive from your investment each year. This is also a good way to compare your different investments with each other. Here you must also take the time that an investment would take to yield returns and the time it would take to get to break-even. The time factor also plays out to know which investment would hold-up what amount for how long. These seemingly complex ideas play out to be rather simple when put in numbers.
The percentage on rent rule varies from investor to investor, but it also greatly depends on the property and the general market condition. But, general consensus is that if the property investment doesn’t yield at least 1% of the investment as rent, than the investment is not worth it. Aiming for higher than 2% also puts risk tolerance into account. This is where the unreliable factors come into play. 1.5% is both safe and practical. But, going below 1% can be termed as a bad investment.
When you are shuffling through plethora of properties, the rent against investment is the quickest way to spate the good deals from the bad ones. Then you may calculate the cash-flow to further narrow down your options and finally calculating return on investment gives you your ultimate hot-list to pick from. Here onward you have to make the decision as to which of the final ones are best for you. Here you have to consider what you expect to receive from this particular investment.