Understanding Yield

[muppet]

Hi Guys

Just received Acumen's mid month newsletter. It has an interesting article for newbie property investors.

Newsletter Details
Show me the money

And that is to understand the numbers. Successful investing is all about having the numbers right. Unfortunately when you talk about yield and equity you get very different opinions and advice, a lot of it nonsense.

So forgive me in advance if this is a bit basic to you personally, but I think even the experienced investor can sometimes forget the basics.

Equity

The term equity as it relates to property is quite simple. The equity you have in a property deal is the difference between what you owe on the property and what the property is worth.
So if you own a property worth $200,000 and a mortgage of $150,000 your equity is $50,000.


Now when you are investing you want to buy below valuation so you have instant equity built in. If you get a deal under contract at $150,000 and your valuation is for $200,000 then you have on paper, made $50,000 on the day you settle. This equity may be utilised over time to help you recycle your deposit out, or borrow money elsewhere, BUT YOU CAN'T FEED YOUR FAMILY ON EQUITY.

I get deals offered to me almost daily that have huge equity in them but they would send me broke. That's why it is absolutely critical that as an existing or prospective investor you understand yield.

Yield

You will see the word yield often stated in real estate adverts. If you ask agents what yield is you will get a variety of answers, some of them dangerous to rely on. One hears of nett and gross yield and even then there is some confusion over exactly what they mean!

But for us as investors this number is what makes or breaks a deal. As a residential property investor you need to know the TRUE NETT yield.

Example.

Purchase Price interest rate 7.8% = $200,000
Rental income @$350 per week = $18,200
Rates = $750.00
Insurance = $500.00
Maintenance (Minimum 1% purchase price) = $2000
Rental vacancy (Min 2 weeks) = $700
Prop Mngmnt fees @ 7% = $1274
Anything else you will pay mowing, water etc.

OK we now have the data to establish the yield. By analysing this information we can make an instant decision as to whether this property is potentially a good investment or not

Outgoings
Interest $15,600 Plus: Rates, insurance, maintenance, vacancy and mangement fees =$20824.

Income = $18200. If you are building a portfolio to provide you with passive income, this figure MUST ALWAYS BE HIGHER THAN THE OUTGOINGS FIGURE.

So this property loses $2624 pretax. As a positive cashflow investor I instantly know to move on to the next deal OR I have to purchase the property at a better price.

Our property spreadsheet will do this work for you and there are several good software packages out there but we MUST understand these numbers. Until you either have some software to assist you or are comfortable working it out yourself DON'T START BUYING. You can get into serious financial difficulty faster than you imagine. If in doubt, come and see me before you start!!!

This is so important I'm going to say it one last time.

DON'T INVEST UNTIL YOU UNDERSTAND YIELD!!!!

If you have any questions or would like help getting your head around this information email me anytime.

Safe investing from Dean and the team

Phone 09 921 0444

https://www.acumen.co.nz

Regards

[Julian]

This column presents some good basic information, but there is one statement, that if followed could leave potential investors walking away from easy money.

I get deals offered to me almost daily that have huge equity in them but they would send me broke.

Why not sell the deal and pick up on the spread (the difference between the purchase price and the price you can on-sell it at)?

Julian

[Dean@Massiveaction]

That's not a good strategy for newbies. Otherwise you're quite right!!

[SJL 01]

Hi,

If I may be so bold, I would suggest that your equity figures are somewhat basic and possibly misleading.

Yes, indeed 200k - 150k leaves 50k of equity, but not all of that 50k is actually avaialble for investinng. Given the the bank requires a minimum security of at least say 10 - 20%.
Basic point I know, however since your article is aimed the the investor starting out, I do feel that you have to make it very simple otherwise they misundestanding and over estimate their position.

Cheers
LL

[Dean@Massiveaction]

Sorry Lucy I don't understand your query. My article says that equity can be utilised OVER TIME to recycle deposits or borrow elsewhere and that is true. If you buy a 200K property and pay 150K you can recycle your 20% deposit of 30K within 6 months.

[SJL 01]

Hello Dean,
Yes indeed I understand and agree that there is 30k of equity that you can use. Howewver your previous article said there was 50k of equity.

My point is that there is a difference between total equity in a deal and the available equity for recycling. Given that most investors are working on a 80% loan against the value.

Cheers
LL

[Dean@Massiveaction]

Hi LL. You're quite right but remember there are many ways to get the whole 80K out within 12 months if you have a good financial education.!!

[fudosan]

I'd like to look at it this way.

1. Purchase property at 150k with 80% financed. 120k from bank and 30k your own money or from other source.

2. Do basic cosmetic renovation, get new evaluation (200k), and then go back to bank again to top up with 40k (80% of 200k) as rc facility. This 40k (including your original 30k deposit) is now available for further purchase. My original 30k deposit has increased to 40k while the LV ratio is still kept at 80%.

Am I getting it right?

[Julian]

fudosan,
You're on the money, but don't forget the incidental costs, such as the cost of the cosmetic do-up, conveyancing, bank charges, communication costs, valuation costs etc.
Julian

[fudosan]

Julian,

It was only a simplied case to illustrate how to recycle/grow the original deposit. You are right, all costs should be included in the consideration.

[Dean@Massiveaction]

Spot on. But even without spending a cent if you buy with an RV of 200k you can refinance it out or cross collateralise (spelling?) and get all 80K out anyway

[RentMaster]

If you choose to do some improvements and then refinance it, then your mortgage interest bill is going to go up. If you have done some improvements then the rent may also have gone up, but there is the potential to take a cashflow positive property and make it cashflow negative.

[nfung]

Re: Understanding Yield

...Example.

Purchase Price interest rate 7.8% = $200,000
Rental income @$350 per week = $18,200
Rates = $750.00
Insurance = $500.00
Maintenance (Minimum 1% purchase price) = $2000
Rental vacancy (Min 2 weeks) = $700
Prop Mngmnt fees @ 7% = $1274
Anything else you will pay mowing, water etc.

OK we now have the data to establish the yield. By analysing this information we can make an instant decision as to whether this property is potentially a good investment or not

Outgoings
Interest $15,600 Plus: Rates, insurance, maintenance, vacancy and mangement fees =$20824.

Income = $18200. If you are building a portfolio to provide you with passive income, this figure MUST ALWAYS BE HIGHER THAN THE OUTGOINGS FIGURE....

Muppet your figures are almost right except I think the Income should be = $18200 minus vacancy lost of $700 = $17500.

Base on this calculation it is very hard to find a positive yield property at the moment, at least in Auckland area.

Does everyone agree?

[learner]

Hi nfung

Strictly speaking, you are correct that the income is $17,500.00, but Dean (in Muppet's post) has accounted for the vacancy as an expense, so there is no difference in the final figure.

You are also correct in that it is quite difficult to find positive cashflow deals at present.

[Dean@Massiveaction]

Sorry to disaree guys but I find pos cashflow in Auckland every week. I spend a lot of hours doing it though!!