Property Investment Terminology
This is a broad guide to terms you may hear in considering the purchase of an investment property. You should seek precise advice on the application of terms to you.
Gross Rental - Monthly or annual rental income you can expect to obtain from your property. For example, $600 per month or $7,200 per year. Multiple monthly rent x 12 to get annual rental.
Net Rental - Monthly or annual rental income, net of all expenses. These can include management fees, service & maintenance charges, repairs, buildings, contents and tenants insurance, inventory charges, allowance for replacement of furniture if furnished and so on. Typically you can expect to lose 15 to 30% of your gross rental on an unfurnished property to various fees.
Purchase Price - Purchase price of the property as agreed with the vendor.
Gross Purchase Cost- Total purchase price plus stamp duty, legal fees, mortgage fees, finder’s or spotter’s fees and so on. You should obtain estimates of these costs before buying as they will add to the investment cost.
Gross Rental Yield - Divide the gross rental income by the gross purchase price. For example, Gross purchase price $360,000. Gross rental $20,000. Gross rental yield is $20,000/$360,000 x 100% = 5.6%
Net Rental Yield - Divide the net rental income by the gross purchase cost. For example, assume our $20,000 gross income falls to $16,000 after costs. Net rental yield is now $16,000/$360,000 x 100% = 4.44%
Net Income - The net rental income, calculated as above, minus your mortgage payments. Suppose your net rental income was $8,000 per annum, and your mortgage payments $5,000 per annum, your net income from letting the property is $8,000 - $5,000 = $3,000.
Free Cash Flow - The amount of cash that a property generates over a period – monthly or annually. This is usually the same amount as your net income, but may vary slightly depending on when payments are made and rent is received.
Generally property investors are advised to purchase property that has free cash flow, otherwise you are committed to funding the property on a monthly basis. However, there are special situations where it would make sense to purchase property with a negative cash flow if it were for a limited period, for example if you expect to resell for a profit in (say) 12 months time.
See also our discussion of Negative Gearing.
Capital Appreciation - The amount that your property has increased in value over a specific period, usually one year. This can either be expressed as a percentage, or as a monetary amount. For example, you purchase for $200,000 and the property is now worth $230,000. The increase in price is $230,000 – $200,000 = $30,000. This is $30,000/$200,000 = 15% growth from your purchase price.
Total annual return - Your total ‘profit’ from a property is made up of the capital appreciation plus your net rental income. For example, your property cost $120,000 and increased in value by $10,000. Plus you received $3,000 in net rental income. Your total annual return is $10,000 + $3000 = $13,000 per annum, or $13,000/$120,000 x 100 = 11% approx.
Equity/Cash in the Deal - The amount of money you need to leave in a particular property will vary from deal-to-deal. It may include; the amount of the purchase not covered by your mortgage loan, legal and professional fees, stamp duty, refurbishment costs, incidentals such as carpets, curtains, white goods, complete furnishings if appropriate, insurance paid in advance an so on. You need to know the total amount in order to calculate your Return on Investment (See below).
Return on Investment - Frequently shortened to ROI. This can be calculated by either excluding or including the capital appreciation. Why should some people calculate it differently? If you never sell your property then the capital appreciation is theoretical, whereas the ROI based on rental income alone is very real. On the other hand, if you view your property as a totality and are willing to sell if it fails to make total returns that meet your criteria, then including the capital appreciation is totally valid.