Benchmarking your IP

[Fritz]

Fellow IP investors,

I have been following several threads over the last 3 months and I get the impression there are more threads on how to claim tax losses in what entity then there are threads on how to improve ones cashflow and make a profit and what distinguishes a good IP from a bad one.

To kick things off, I would like to know what IP investors benchmark their investments against ? What ratios do they use to determine what makes a good IP from a bad one and some definitions.

Who in this forum looks at net yields or net return on investment?

How about Return on Investment (not the internal rate of return) ?
Simply the return on the cash you have in the deal allowing you to compare a bank interest rate with a Ip interest rate ?
Say bank pays you 7% (before tax) and compounding compared to a deal where 12K of your money return you 4.6% on that 12K (before tax).

What weighing factor you use for c/g to make a decision wether that 4.6% IP is in favour of a 7% bank rate?

When to stop?

What other factors do you use?

Away we go.

Fritz.

[Josko]

Since you've yet to get an analytical response Fritz...as at edit time,

I will display my newbiness...

I have been following several threads over the last 3 months and I get the impression there are more threads on how to claim tax losses in what entity then there are threads on how to improve ones cash flow and make a profit and what distinguishes a good IP from a bad one.

I truly do not believe that one sets out to invest in property solely to claim tax losses. Your implication seems to be that a -ve geared property is somehow the antivestment, and that the discussion should be around whose +ve property beats mine and why.

Personally I see the -ve geared property as a vehicle to invest in more desirable areas, ones that I would live in my self. This is simply because I am investing for the long term. 15 years +

This was until I joined PT, and I am slowly adapting a desire for that +ve, “I get extra in my pocket every week investment”, though I am fearful of having to go to akumatata to achieve that result.

To kick things off, I would like to know what IP investors benchmark their investments against ? What ratios do they use to determine what makes a good IP from a bad one and some definitions.

So far a bad IP’s to me seems to be the ones managed badly, and those that Glenn entertains us with. (kidding around Glenn)

Who in this forum looks at net yields or net return on investment?

Never thought about it until PT, now happy with 7% gross and 5% compounding capital gains over 15 years. (May adapt that, if I find some motivated sellers).

How about Return on Investment (not the internal rate of return) ?
Simply the return on the cash you have in the deal allowing you to compare a bank interest rate with a Ip interest rate ?
Say bank pays you 7% (before tax) and compounding compared to a deal where 12K of your money return you 4.6% on that 12K (before tax).

Not having fun any more...

What weighing factor you use for c/g to make a decision whether that 4.6% IP is in favour of a 7% bank rate?

Will never invest money in a bank again, unless it’s their shares.

When to stop?

The journey never ends....

What other factors do you use?

My Finance 101...if I am not having fun...

Having a little fun here at the expense of a good question Fritz, do you really do all those calculations on every opportunity.

Here is another bit of fun, if you’re reaching crusty time, then sure all these details will be most important, the bank is safe and your returns will be relative to when you require the optimum result.

Regards, Crusty mischievous sprite....

[Julian]

Fritz makes some good points. Those who focus primarily on reducing their taxable income through property losses may well be missing the big picture of after tax profits.

Julian

[Muddle]

Fritz

Your extremely valuable posts are a gold mine of good information. You reguarly have me thinking and reviewing my situation. Particuarly with my company setup.

My situation is :

Formed a company and bought properties returning 13.9% gross in 2003 . Turned the co. into a LAQC 2004. Have only one mortgage.
I am very fortunate in that I do not have to work reguarly, as the rentals provides me with the majority of my income.
But recent posts regarding C+ IP's within a LAQC has made me question my original intention of offsetting tax losses. I am very ignorant when it comes to accounting and leave that all to my accountant.
I know this is digressing but clarification would make me sleep better.

Regarding my buying criteria :

I bought run down houses in average to good suburbs. Resale was a major consideration. Back in 2003 there where plenty of opportunities, especially in Wanganui, to purchase C+ IP's. Then it was just a matter of getting in first with an offer.

I benched marked my income against interst gained if my money was in a term investment with a bank.

I do not look at net returns because this last year I have been nearly full time doing up the IP's. Painting being the major pain. So my rental income is frequently depleted by maintenance costs.

I have decided that next year I will review my situation. The property maket should have sorted its self out and it will be easier to get a clearer indication of which direction it is heading. Though I will never completely close the door on any opportunity, whether it is tommorrow or in 10 years time. My personal opinion is the Wanganui market still has some upward movement to go. If you compare the REINZ's last valuation of $128k and compare it to the national average of $280k, there is still room for improvement. But before people go out and buy Wanganui IP's please consider that there is a negative population growth. Wages here are still below the national average and that reflects on the rental income.

Ignorance isn't bliss when it comes to money.

Barry

[mrmarketing]

Interesting question for a mature portfolio

The notion of measuring return on original investment in an IP can tell one story, but looking at one's alternatives with a property that has appreciated in value is another. This is the dilemma I am currently facing.

Let's see if I can illustrate:

Let's say that 10 years ago I bought an IP for $100,000 and that I invested $20,000 initially. Then I could look at what I gain each year in terms of that original $20,000 (assuming no further investment in the intervening years just for simplicity of argument's sake, i.e. -CF, improvements, etc.). Gains are +CF, appreciation, tax credits, mortgage principal paydown.

Now, let's say that the property has appreciated to $250,000.

If I were to look at the current year returns as a % return on my original $20,000 it would look really good.

But I have an alternative. And that is to sell the property, pay off the mortgage (let's say paid down to $70,000), and then I could have $180,000 in the hand (i.e. $250.000 - $70,000).

The question then is what is the best thing to do with the $180,000? i.e. leave it in the current property, or do something else with it? So now I think I have to evaluate the best way to get a return on $180,000, not on the $20,000 I originally put in (since isn't that really where I'm at?)

i.e. if I continue to ask the $20,000 return question versus the $180,000 question, I think I see two different answers.

And this might be especially pertinent if we are coming to a property valuation plateau like I (we) experienced over the late 1990s (not saying we are, but it feels like a good possibility soon - especially with personal incomes not keeping pace at all with property values, and that we're not seeing comensurate significant rent-paying ability increases??).

Alternatively (but somewhat aligned with this thinking on a somewhat matured IP portfolio) if we are to use annual cash returns (whether nett or gross) should we be using our original purchase prices, or should we rather be using the current est. Registered Valuations each year to form the Cost/decision basis'?

(I am a newbie to this board - and I have a portfolio of IPs in the Chch area that I accumulated in the late 1990's)

Thanks for the discussions. Martin.

[The_Dog]

I started about 13 years ago with 20k, and have calculated I have grown at a compound interest rate of about 43% pa to where I am now.

I have injected cash along the way, but not a hell of a lot, not enough to cramp my lifestyle!! and only in recent years (4 or so). There is a lot more I can squeeze out of my existing portfolio were I in the country, converting 2x2 beds to 3 beds and putting secondary dwellings on another 2 properties. so this would bump things even further. I also have 10 years of accumulating depreciation I am yet to include in these figures. Tax doesn’t worry me as I’m off shore.

So, do I benchmark against what I could get in the bank? No.

I decided that the returns from housing are the best available over the long term, and jumped in boots and all. I have dipped in and out of other investments, but always got burnt.

I benchmark internally, mainly using my annual tax return. I calculate the percentage fees, the % occupancy, the % maintenance. I compare them between properties and between years. Where costs for a particular property are out of whack, I slap them about until things are on a more even keel.

Had I dithered wondering about tax structures, and chopped and swapped things from one investment vehicle to another, where would I be now?

Well, probably not where I am now would be where I would be. (if that makes sense)

The Dog

[Julian]

Welcome mrmarketing.

You can do your calculations based on your original purchase price or on current values, or better still, both! At the end of the day the important thing is that you are happy with your investments and they are delivering the goodies for you.

The-dog,

Couldn't resist getting the calculater out and seeing you have turned $20k into over $2m - a 10,300% increase over 13 years! That is absolutely brilliant, especially as you have done it by remote control from the UK, and your figures exclude the benefit of claimed depreciation. You are doing much better than Warren Buffett on a percentage basis - mind you he's been doing his investing thing for much, much longer.

What areas have you bought in? Perhaps you might like to set up a new thread, like Steve Goodey and Ron Hoy Fong have done, telling the rest of us you you did it. Threads such as this are incredibly inspiring.

Regards,
Julian.

[The_Dog]

Steady Tiger!!

Two things here. Actually a few. I appear to have make a slight mistake in that the growth is 39% and not 43 (always remember to drag the excel formula down!!). Also, I think I may misinterpret what 'compounding growth' means. This is how I did it...

Year 1 £20,000 x 1.39 equals
Year 2 £27,800 x 1.39 equals
Year 3 £38,642 x 1.39 equals
Year 4 £53,712 x 1.39 equals
Year 5 £74,660 x 1.39 equals
Year 6 £103,778 x 1.39 equals
Year 7 £144,251 x 1.39 equals
Year 8 £200,509 x 1.39 equals
Year 9 £278,707 x 1.39 equals
Year 10 £387,403 x 1.39 equals
Year 11 £538,490 x 1.39 equals
Year 12 £748,502 x 1.39 equals
Year 13 £1,040,417

Which doesn't give me 2 mill. Have I got it wrong?

I reading Warren Buffet at the moment actually.

Anyway, my exploits are already documented in the New Zealand Property Mag. A lot of my growth is in my uk property, which had doubled in price since purchase Although I did get it at a 21% discount from registered valuation (about 4 years ago).

There is not much to it, just a bit of discipline and running a tight ship. And time, growth over time. All the fancy value adding strategies will have to wait till I'm back in NZ.

That's why I say jump in! All the newbies are getting hung up on finding the perfect deal and all the while things are slipping away. You're better (in my opinion) to get your feet wet with a property which you are happy with (i.e, not a Dumb Deal just for the sake of it ), but it might not be the deal of the century, but you will learn so much, and each subsequent deal with be easier. I really struggled into my first property. No bank would touch me as I was young on $18k a year. It took me 2 or 3 years. My easiest deals were 3 to 6. Once you have things rolling, you're away. Now things have tightened up again and my serviceability is a problem

Anyway, I'm not sure about inspiring, but I hope a little encouraging. Inspiring is the Hamilton Lady in the May edition of the NZ property Mag. Wow. Looks like there is money in pet stores!

The Dog

[Josko]

how I did it...

Year 1 £20,000 x 1.39 equals
Year 2 £27,800 x 1.39 equals
Year 3 £38,642 x 1.39 equals
Year 4 £53,712 x 1.39 equals
Year 5 £74,660 x 1.39 equals
Year 6 £103,778 x 1.39 equals
Year 7 £144,251 x 1.39 equals
Year 8 £200,509 x 1.39 equals
Year 9 £278,707 x 1.39 equals
Year 10 £387,403 x 1.39 equals
Year 11 £538,490 x 1.39 equals
Year 12 £748,502 x 1.39 equals
Year 13 £1,040,417

Which doesn't give me 2 mill. Have I got it wrong?

FV = PV x ( 1 + r)^t

Where:
FV = Future Value = 1,040,417.00
PV = Present Value = 20,000.00
r = Rate = ?
^= to the power
t = Number of Periods = 13

I get Rate to be 35.52, however its on a calculator with 4 decimal places calculations.

and now for the currency converter $2,687,436.09 voila...mmmmm...nice very nice....

Dont mind Julian.... The_Dog, he likes a bit of creative tension in his writings...

That's why I say jump in! All the newbies are getting hung up on finding the perfect deal and all the while things are slipping away. You're better (in my opinion) to get your feet wet with a property which you are happy with (i.e, not a Dumb Deal just for the sake of it)

I agree, still, be careful out there...

[Julian]

The-dog,

I don't bother with complex formulars. I just pressed in 20,000 in my calculator and then went + 43% 13 times.

I notice you only show 12 years of growth. The starting point is $20k. Count the times you did the multiplication.

The difference is the difference between 39% and 43% and 12 years vs 13 years.

Anyway that is all by the by. Thirty-nine percent compounding growth over 12 years is still brilliant. And you show it in pounds so the end result in NZ dollars is found by dividing by (about) 0.38 to arrive at $2, 736,842.

That's what I call a handsome amount of capital. Nice one!

Julian

[The_Dog]

The Dog needs to clarify here. He's a ordinary type dog, in Kiwi dollars type dog.

First house - black Friday, March 1992. Equity $NZ 20,000

Position now (08/05/05) - just over a mill $NZ equity.

What formula is used to determine the rate of return to get from one position to the other is subjective. This figure is subject to market forces and exchange rate. Old Dogs should not try to learn new tricks. Warren Buffett still rules.

The Dog

PS. If someone would like to tell me how to return to the days of NZ$3.63 to the pound exchange rate, please do so.

[Fritz]

Benchmarking your IP

To the benchmarking team,

there seems to be 2 discussions going on at once:

1) How to evaluate an IP at ground zero, ie when buying
2) Discussion on maturing IP portfolio, muddle, mrm and co.

As to the originally intended debate I am suggesting to look at op net returns or what aco****ants call EbitDA (earnings before interest, tax, depreciation, and ammortisation) as a benchmark.

Why is that you say? Well, to my logic borrowing, depreciating are given, ie similar. Expenses however vary greatly. A 100K townhouse returning 10K and a body corp unit 100K returning 10K on the surface all look the same, after all you are getting 10% gross.

However looking closer, the 100K townhouse has revenue of 10K, costs (r&m, vacancy, pm BUT not interest) of 2K ie 8K ebit over a 100K investment would give you 8%.

The 100K unit has revenue of 10K, costs of 3K (body corp and other BUT not interest) so 7K over 100K this is only 7%.

This would take into account things like body corp if there are any, or high r&M or high vacancies, wtaer charges, etc and would let you compare apples with apples, units, versus local towns, versus minor dwelling, versus townhouse.

The second one I would propose is the return on your money and this factors in gearing, ie how much are you borrowing.

Say you have 10K in that original 100K, at 7.6% interest ($6840) you are left with a profit of $1160 so 11.60% on your original 10K.

Should you gear higher (borrow a higher percentage) and say have only 10 dollar in it (if it is none return would be infinite), interest would be $7600 on 99.99K and you would make $400, which is a 4000% return (beats the bank)

Ivi, yes I do these calculations all the time (actually my laptop does) and it lets me evaluate if this is a good deal or not.

Using these benchmarks you will be able to look at a deal far more objective then gross yield. Hands up how many ads have we seen out there '9.8% yield' and found out on reading the small print that actually excluded the body corp, water rates, manegement fee, etc) It is confusing bordering on misleading to see some of these. The industry as a whole would be better served by a uniform yield ie

ALL REVENUE = $R
ALL EXPENSES = $E (but not interest, tax and ammortisation)

TOTAL value on purchase= $V

EBITDA = $R-$E
Yield %= ($R-$E)/$V*100

To again translate this into banks you can now compare one IP with another just like an interest rate from bank to bank.

And yes there is depreciation, and tax, but they are a given, and should not be the factor to decide to buy IP's, but an additional bargain.

While this all sounds technical, and yes crusty, knowing these numbers makes me sleep at night. On my first 2 IP I really had little idea what it all meant but I am now approaching it from a more commercial angle, and boy has it also made a difference with some lenders.

To the second question, and one I am facing now.

IP appreciates over time, what value to use to evaluate wether to buy, sell, hold, refinance, or what ????

Say I bought 1 IP for 50K (I have) 3 years ago (it is now worth 130K), what figures do I base my decision on ??? (let's assume there are no tax issues whatsoever) purely thought experiment this is.

It makes about 9K revenue, so on purchase ratio (2K costs) ebitda yield 14% (9K-2K = 7K/50K). Pretty good. On current value 130K it only makes 5.3%. soso..

Which way to go:

a) sell, invest the gain of 80K somewhere else?
b) sit tight, keep renting it and reducing the principle to zero ?
c) re-morgage

I have decided to go the second way for several reasons and with a slight variation: I have remortgaged to 78K making it neutral cashflow on p&I paying it off, giving me some capital without selling it, using part of it to invest again and part of it to make the house extra nice for the next 5 years guaranteeing good rent and happy tenants and a rent rise.

Anyone that is still awake after all this, would be good to hear other ideas on how to evaluate portfolios, what to do, and how you look at it.

I have to say as Ivi pointed out it is as much a personal decision and neither my ideas nor any others are any better or any worse. There are many ways to wherever you want to go.

Benchmarking has simpy allowed me to see wether I can employ my resources in other areas in a more efficient way. To use the Covey analogy, it is not just the speed with which we are climbing the ladder, the question should also be is it the right ladder ???

This is for you to decide, and no matter how much numbers you crunch, the meaning of life will not be spat out by a calculator. (unless you are watching the hitchhikers guide to the galaxy, then it is 49)

Have fun you all out there. And enjoy.

Fritz.

[Gerrard]

Hi Fritz - thanks for the run down. That's stuff I've never really understood before. The only problem I see is that within EBIT there are still a number of possible/variable expenses. e.g. I may choose to use a property manager, landlord insurance, etc, whereas you may not. Given these differences how can we truly benchmark between what we are doing?

Gerrard

[Fritz]

there are still a number of possible/variable expenses. e.g. I may choose to use a property manager, landlord insurance, etc, whereas you may not. Given these differences how can we truly benchmark between what we are doing?
Gerrard

Gerrard,

good point. I simply accounted for all expenses incurred as if it was a total hands off investment so it truly benchmarks to shares or interest received.

I would think p/m, R&M, insurance, vacancy, rates (b/c, water, etc) would be included to compare apples with apples. Any we have missed ?

It is still more transparent then gross, but needs some refinement.

Fritz.

[whitt]

another approach is caculating cashflow per $100,000. Keiran uses this approach and like wise it is able to compare different properties.