Wednesday, August 21, 2013

Calculating Rental property yield.

As I make new cash deposits into my portfolio, I have to determine where the money is going to go to. How will it best achieve my goal of increase income? Do I buy more stock or pay off my mortgage early?
I have to have a way to compare different asset classes with each other. So to compare the income from real estate I frame it in terms of dividend yield.
There seems to be many ways to look at your rental income so I will share with you guys how I view and calculate it. This is for comparison's sake across different asset classes, this is not for tax purposes.

A dividend paying stock takes in revenue for its product or service it sells. Then it applies its costs, and from its profit it pays its investors a dividend. The company announces the dividend amount to the world and its not open for debate. As far as receiving the dividend, the investor doesn't have to worry about these costs, they just get paid.

As a landlord our rent is revenue, it is not our profit so we cannot just use that to calculate our yield. If we want to compare our real estate income as close as possible to a dividend, we have a cost of doing business that must be paid before we can have our profit.

What's more is that our costs are not static. Some months you will replace your furnace taking 2 months or more of rent. You could go a year without having any repairs. Thats why I set aside and estimate 10% for repairs and vacancy. Its not exact but we need something to base our calculations off of.
I use my net rent as shown on the spreadsheet for calculating yield.
But wait its negative. We can't calculate our yield on a negative income, that's a loss.

Almost all of my costs are flexible as to if they occur and in some cases by how much. However they will have a chance to occur for as long as I own the property so I need to plan for them. Well all but one of them. The mortgage.
Once that is paid off it will never come back. Its a known, quantified cost that can be removed. Once we remove that we can get our long term income estimate. This also makes it closer to what a dividend would be.
That's why I use Net Rent with no mortgage as my long term calculated income for yield purposes.

Net Worth
The other half of the yield equation is how much is the property worth that I am calculating my yield off of. Real estate is very illiquid. One property doesn't have a million points of view a day setting the price on the active market.
I could use the current balance of the property. How much profit I have tied up into the property. If we are to look at capital gains of a dividend paying stock as being tied up into a position that could be sold and deployed in another stock this makes sense. However if I am looking at my net rent at a future point in time then to be fair I need to look at my property's net worth in the same way. Additionally, I plan to keep this property forever barring any local economic disasters so at some point I will have the mortgage paid off. Since this portfolio is to get me retired from my day job, this plan fits in with my strategy very nicely.
The estimated value I have as the average between,,, and what my local county charges bases my property taxes on.

So what is my yield?
With all that said I have two yields listed.
The gross value yield is my rent before costs / estimated value.
The net value yield is my net rent / estimated value.
Why would I use both? Because some of these costs are unknown over the course of the year, I use these as the highest and lowest estimates. The true yield will be somewhere in between.

Disclaimer: The investments and trades discussed are not recommendations for others. I am not a financial planner, financial advisor, accountant, or tax adviser. The financial actions I talk about are for my own portfolio and money and only suited for my own risk tolerance, strategy, and ideas. Copying another person's financial moves can lead to large losses. Each person needs to do their due diligence in researching and planning their own actions in the financial markets.

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