Property deal analysis can be complicated. Over time we learnt that there are 5 main ways to effectively analyse a property deal, specifically Buy To Lets and HMO’s.
It turns out that more than half of investors deviate from what appears to be a deal in their mind, either by way of getting their numbers wrong or giving in to emotions towards the property.
Few of them probably do not know how to do property deal analysis and rely on 8% to 10% gross yield figure that estate or sourcing agents say, is the best in the country.
It does not have to be that complicated.
This post will cover on how to perform property deal analysis for buy-to-let and HMO properties in detail with definitions and explanations.
Gross yield is the yield on an investment before deduction of taxes and expenses.
Its calculated as annual return on investment prior to deduction of taxes and expenses divided by property purchase price.
Gross yield = annual rent / purchase price
Therefore, if you get presented with a property where the gross annual rent is £7,200 and the purchase price is £72,000 then your gross yield is 10%
Gross yield is what a lot of estate agents will use to try and lure you in to buying a property.
As an investor though, you are probably wondering what the cashflow is?
That is the challenge with gross yield. Until you dive deep into the numbers, you will not be able to know.
Gross yield doesn’t take into account mortgage payments, void periods, MOE (Monthly Operating Expenses) or even management fees.
Gross yield can be used as a very basic indicator for any property deal analysis.
There are investors that solely base their investment decisions on gross yield. There is nothing wrong with this and if that is what works for them, then superb.
As we always say, as long as everything you do is under the ethical win-win umbrella and it works for you, then there is no right or wrong in property.
Net yield gives you a much better understanding as it takes into account management fees, MOE and mortgage payments.
To calculate net yield, you need to deduct all the expenses from the gross annual rental income. You then divide that number by the purchase price of the property and multiply by 100.
Net Yield = (gross annual income) - costs per annum/property value x 100
If you had a property that had a gross annual rent of £7,200 with total annual costs of £3,600 then your net yield would be 5%.
This is a big difference from the gross yield of 10% on a property with exactly the same rent and purchase price.
It is more than likely that your net yield figure will always be lower than your gross yield figure, as net yield is designed to take into account the costs associated with running a property.
Net Return on Cash Left in Deal (ROI)
Net return on cash left in a deal (or Net ROI) is slightly different from net yield as Net ROI only takes into account the money that you put into the deal. It does not take into account the amount on the mortgage (if you are purchasing with a mortgage).
Return on Investment = Net Profit / Total Investment * 100
The above example shows that the legal fees, finance and survey costs and Stamp Duty Land Tax (SDLT) are taken into consideration.
Also, you will see from the column on the left that there is a total investment of £75,960 (if no mortgage is needed) or a total of £21,960 assuming that a 75% LTV mortgage is taken out and that the bank will lend you £54,000 as long as you pay the 25% deposit which equates to £18,000.
Note how the Net ROI jumps up to 17.62% when a mortgage is taken out.
Note the cashflow of £322.50. Cashflow is incredibly important in property and some investors will only invest into a below market value property if they know that the cashflow is above a particular amount per month.
Net ROI provides a more in depth property deal analysis than gross or net yield and is also able to provide you with a likely monthly and annual cashflow figure for a property. This is the most important dynamic for some investors.
Net Return on Cash Left in Deal after Remortgage
Net return on cash left in deal after remortgage is the other metric that you can use to effectively analyse a buy to let or HMO.
This metric only works if you know that you are getting a discount on the original purchase price.
If you are not getting a discount on the original purchase price or the property has not been undervalued in any way then Net ROI after remortgage will probably not be applicable to you for now.
For example, if you know that when you buy the £72,000 property that has an annual gross rent of £7,200, that you have bought at a discount and that the true value of the property is £90,000 then you will more than likely want to remortgage and get some of your original deposit money back out in the future.
From the table above, you will see that if you remortgage onto the same mortgage product (75% LTV at 3.5% interest only per annum) but at a new property value of £90,000 then you will only have £8,460 left in the property deal with a slightly reduced monthly cashflow of £283.13 yet a Net ROI of a 40.16%.
40.16% is much better than the 17.72% Net ROI before refinance and indeed the 5% net yield.
This metric really shows you the true Net ROI of a property should you be able to buy the property at a discount in the first place.
It is common for investors to not think about yield too much and to just focus on the cashflow instead.
This is perfectly understandable as cash is what you see coming into your bank account as an investor month on month.
Cash Flow = Total Income - Total Expenses
The total income if you consider a Buy-To-Let will be monthly rent multiplied by 12 months in a year assuming there are no void rentals.
While the total expenses can include many thing like mortgage payment, insurance, lettings fee, expenses and others.
Once you take out the total expenses in a month you spend on a property from the total rent, whatever is left is your cashflow per month.
If the estimated cashflow is less than zero, simply walk away from the deal.
Should the cashflow be higher than zero, then set a minimum cashflow you wish to achieve per month before purchasing a property. Usually we go for atleast £100 cashflow per month when mortgage interest is 5% or below.
The only difference between the HMO calculator and the Buy To Let calculator is that Bills have been added.
A general rule of thumb is that 40% of your gross rental income will go on HMO Management, MOE and bills.
The example above is based on a 6 bed HMO, let to blue collar workers, at full capacity throughout the year with each tenant paying £85 per week on an all inclusive basis.
The example above is also just based on buying a ready made HMO (which adheres to all of the necessary HMO Management Regulations etc)
The management has been set to 12.5%, MOE at 10% and bills at 17.5%.
If you intend to operate student HMO’s and they pay their own bills, then your bills section is likely to be less but your refurb costs might be higher every year.
Other Important Points
You do not have to include MOE when analysing your buy to let or HMO deals. MOE is something that we like to include in our own property deal analysis as we always like to have a cash buffer per property to cover any void periods or minor repairs.
You do not have to include the cost of management fees when analysing your buy to let or HMO deals but only if you are managing yourself and not charging yourself a fee for doing so.
There are always variables.
For example, you may decide to have an 80% LTV mortgage or your management fees may be 12.5% rather than 10%.
You may decide to have your MOE set at 15% and not 10%. The mortgage interest rate may even be different, it maybe higher or indeed lower.
The Stamp Duty will inevitably be different too, along with the costs of legals and the finance.
There are 5 main ways to effectively analyse a Buy To Let or HMO property. Each method is slightly different and you have to do what works for you. There is no right or wrong as your property business is yours and your metrics are yours. If you decide your investments on cashflow then great, if you decide it on gross yields anywhere above 10% then superb. Do whatever works for you and your strategy.