One of the tools property investors use regularly for a quick assessment of the attractiveness of an investment opportunity is what is termed as Return on Investment or ROI as it is commonly known. This is not the only calculation that investors work on to calculate returns; however, it is the most widely used in the market. Let’s take a closer look at what is ROI and how to calculate it.

ROI is calculated to determine the feasibility of your property investment. It is designed to assist the investor in answering all the common investment questions, “Is this investment worth it?”, “What will I get back in return?” and “Which investment option is more attractive?”.  The return on investment measures how effectively your investment/property uses its capital to generate returns. Therefore, naturally, the higher the ROI, the better rated the property investment opportunity is.

As with any type of investment, before you proceed to put your time, energy, effort and money into an investment, you must have an indication of the kind of returns you will get in exchange; not only how much you will get back in return but also an indication of when it is expected. ROIs are a good form of comparison to determine which of your investments or investment vehicles is making your money work the best for you.

ROI or sometimes termed Yield is the percentage of money gained (or lost) on an investment relative to the amount of money invested. The amount of money gained (or lost) may be referred to as the asset, capital, principal, or the cost basis of the investment. Yield is usually expressed as a percentage rather than a fraction. Yield does not indicate how long an investment is held for. However, Yield is most often stated as an annual or annualised rate of return, and it is most often stated for a calendar or fiscal year.

In this article, Yield indicates an annual or annualised rate of return, unless otherwise stated. Return on Investment indicates cash flow of an investment to the investor over a specified period of time, usually a year. It is a measure of investment profitability, not a measure of investment size.  

How Yield is Calculated

In its simplest form, to calculate Yield, the benefit (or return of money or income gained) of an investment is divided by the cost of the investment. Yield is usually shown as a percentage. This formula can also be used to suit a number of different situations. Here is the formula for Yield:

(Income from Investment – Cost of investment) /
Total Cost of Investment = Yield

When working with an investment property, it is best to determine each cost over the course of a year to find out the yearly Yield.

For example, if RM500,000 were put down to purchase an investment property and I had to spend another RM80,000 in property renovations etc. then my total invested sum so far would be RM580,000. Let’s say in this example, I paid cash for this property, therefore no loan is involved. Assuming the rental is RM3,000 per month which will translate to RM36,000 per year, it would mean my Gross Yield is:

RM36,000 / RM580,000 = 6.2% Gross Yield

To make the Yield figure more reflective of the actual returns I am getting for the property, I must deduct from the annual rent figure the cost incurred on the property i.e. Maintenance Charges, Sinking Fund, Management Fees, Insurance, Quit Rent, Assessment, Estate Agent & Legal Fees (where relevant) and other expenses.

Working out the Yield for each of the property investment options available to you at a particular time, will aid you in comparing and selecting investments that bring forth the best returns for you. It also serves as a good reason for you to reject less attractive investment options and assist you in making a decision.

However, at present we base our returns on the yearly rental and not the ultimate return you will get when you sell the investment property.  Yield and expected Capital Appreciation must be considered together in order to make better decisions on the investment option. Some investment property will be lower on yearly Yields but over a shorter period of time can double in property value.

As a general rule of thumb, seasoned investors would go for a property investment which has a nett yield of twice the fixed deposit rates, which in this case would have to touch no less than five per cent. How can this be achieved? There are only two ways, as per the formula – either the rental can improve or reduce the purchase price. Say the seller is willing to consider a price of RM450,000 and a more reflective rental is RM4,000 per month, your gross yield would now hit 9.1 per cent.

When considering completed properties in the secondary market, check out the current rentals the property is fetching. You can do this quite easily by checking with your local real estate agent who focuses on the locality you are considering. Should it be lower than market rates, there is a strong possibility that you can adjust the rent upwards at the next review, thereby improving your returns instantly.

However, the reverse applies. Be mindful of short tenancies if you charge above market rates. The returns may seem attractive in the short term but once the tenancy terminates, new tenancies may not fetch the same prices and your returns will likewise fall.

It is important to take note of the Tenancy Schedule, the tenant’s standing, past records, duration of tenancy, renewal of tenancy for rent reviews and so on, as all these will have bearing on the quality of the investment. I know of some investors who are willing to commit on an investment of slightly lower yields, but have solid tenants who pay the rent on time and are, to a certain extent, “hassle-free”.

Yields for commercial properties (shoplots and offices) and to a large extent, new high-rise residential properties (condominiums and apartments) average in the region of  six to nine per cent. Landed residential properties such as single or double-storey terrace houses return around three to four per cent.

However, most will agree that traditionally, landed residential properties have greater upside in the capital appreciation department. Then again, location is very important. It is a demand and supply issue. The demand would be good in certain areas where land is scarce.

When considering properties under construction, property developers today offer good incentives designed to make it easier for investors to purchase and profit from the potential future returns. 

In the past, during the construction period, further investments will have to be made toward ownership of the property but today with the right packaging i.e. zero interest during construction cost, you basically only pay the down payment and nothing more till you receive the keys to the property. I know of a prominent new commercial project in Petaling Jaya going at only RM255 psf - which is a very attractive rate! - and on top of that free legal fees, zero interest during construction period and free maintenance for one year upon vacant possession. There is also another package dedicated to investors where a 16 per cent return for two years upon vacant possession is guaranteed. 

This means that with only 10 per cent of the purchase price, you get to lock in your interest on the entire property and benefit from the capital appreciation or rental returns immediately upon completion two to three years from today. These opportunities are worth considering. Of course when it comes to properties under construction, the track record (branding) of the developer is extremely important to ensure the completion of it.

Conclusion

Here are a few good rules: always have at least one month’s living expenses in current account, always have three to six months of your monthly living expenses as emergency funds and you can invest the surplus.