Key terms you have to know and understand
A lot of people when starting out in property can get confused when looking at the numbers side of stacking a deal.
You hear BMV, ROI, Yield, Gross Yield, Net Yield, Net return, Capital growth and more. But what do they all mean and which is the most important?
Let’s start with what some of the above actually mean
BMV
BMV – Below Market Value, it’s normally calculated in both a financial number as well as a percentage, this essentially means how much are you saving against the value others would put on this. This little acronym is highly contentious as Value normally is determined by how much someone would pay for something and hence if you are buying it for x that could indeed be considered the market value. Others would say that if you are able to get in early or direct to the seller and snap it up a bit cheaper then it’s right to see it as lower than someone else might pay had they had the chance. Either which way, how much this number means to you will be down to your strategy (see my other post on Strategies for Property investing). If you are looking to flip, refinance, accumulate capital equity or just like to bag a bargain then the higher the number you get here the better your deal will be.
Consider the following scenario: You are looking to Buy, Renovate, Refinance, Rent (BRRR).
If you find a property listed for £200k and you think after some work (£20k) it could be worth £240k. Buying it at ‘Market Value’ £200k at 80% means a £160k mortgage and £40k deposit. At the end of the project you have spent £220k on the property, £40k of which is a deposit and £20k refurb money. When you refinance, if you get the full £240k figure then you refinance at 80% you would get a mortgage of £192k meaning you end up leaving £28k in the deal.
£200k – £160k Mortgage +£40k Deposit + £20k refurb costs = Total £220k
£220k (total spent) – £192k (mortgage funds) = £28k (cash left in the deal)
Now consider the same scenario but you have bagged the property for 20% BMV, that means you bought the same property for £160k. Same work needed and same end value. Now your figures look like this
£160k – £128k Mortgage + £32k Deposit + £20k refurb Costs = Total £180k
£180k (total Spent) – £192k (mortgage funds) = £12k PAID OUT = £0 cash left in the deal
As you can see, buying Below Market Value has significant benefits. (I appreciate the sums above are not considering many typical costs like Stamp Duty, Conveyancing, finance costs etc, this is simply to demonstrate the difference buying BMV can have.)
ROI
ROI – Return on Investment. Simply put how much money do you get back for the money you have put in.
ROI=Annual profit (income minus costs) / The cash used to purchase the asset (cost)
ROI is typically a % figure so allows you to easily compare different investments, either property or otherwise.
On a property deal, where by you would be renting the property, ROI could look like this.
Purchase price – £200k, Deposit @80% =£40k – £10k for stamp duty, legals and other purchasing costs – total cash needed £50k
Rent – £1200. Costs of around £785 (mortgage, rental management, insurances, voids etc) leaves £415 per month. This is around £5k per year net rental income (ish)
ROI calculator would look like this
£5k Current profit from the investment
£50k Current cost of investment
So ROI = 5000/50000=10%
In other words in 10 years time you would have received all your initial investment money back (and still own the asset both in-terms of equity and ongoing net profits from it. Win Win)
This is useful as you can compare many different properties against this figure quickly and easily. As a lover of spreadsheets, I have a prebuilt calculator which I can add 3 or 4 figures into and it spits out lots of key information, ROI being one. If you would like a copy, please email me on the email at the top of this page.
Gross and Net Yield
Yield – Thanks to Investopidea (with a minor spelling correction to ensure the English version) Yield refers to the earnings generated and realised on an investment over a particular period of time. It’s expressed as a percentage based on the invested amount, current market value, or face value of the security. It includes the interest earned or dividends received from holding a particular security.
There is Gross Yield and Net Yield, Gross yield is the Yield before you deduct any costs and Net Yield is after deducting said costs.
So using the same figures above a £200k property with purchasing costs of £10k, Generating £1200 per month in rent would look like this
Gross Yield
1200*12 = £14400 Yearly income Gross
£210k – total cost of asset including purchasing costs
£14400/£210000 = 6.86% Gross Yield
Net Yield
£14400 yearly income with costs of £9400 (£783.30*12) = £5000 (give or take for ease of numbers)
Same £210k total cost of the asset
£5000/£210000 = 2.4% Net Yield.
As you can see when you factor in costs the numbers do look drastically different. The Net Yield you should look to achieve will again different depending on your strategy. Longer term investors will accept lower net returns now for future capital growth, however too low and any big expense can wipe out all profit to be careful.
Capital Growth
Capital Growth is a longer term play generally, the idea is property values will, over the long term, continue to grow, over short term this isn’t always the case, think 2008 or even potentially now after COVID-19 where property markets crash, but over the longer term periods 10+ years growth is expected. For example my Grandparents purchased their house for £8k about 60 years ago, today that house is worth around £800k. Now, most investors might not be looking at 60 year terms but even over 10-20 years you would expect the values to be significant enough to either, refinance and use the cash, sell and use the money to live from or for some, if you have say 10 properties, you could sell 2-3 to clear all mortgages from the other properties and have no debt against those properties.
For most this is a benefit that will happen but isn’t planned into any calculators as its very speculative and very hard to accurately calculate.
If this is your strategy then ensure you are comfortable with the shorter term gains vs the longer term gains when calculating your overall returns.
Above are a few of the terms used in property and it’s important you understand them all to align with your strategy. Get comfortable with how to calculate these on the fly when out viewing properties to be able to make immediate offers knowing roughly your potential returns