Knowing Your Numbers: A Key to Successful Property Investment

When buying a property, knowing your numbers is crucial for making informed decisions and avoiding financial pitfalls. Many property investors rely solely on the repayment figures provided by their bank or mortgage broker. However, the numbers involve much more than that - it’s also about evaluating your potential return on investment and ensuring the property aligns with your financial goals.

In addition, holding costs, including mortgage repayments, property taxes, insurance, maintenance, and utilities, can significantly impact your cash flow and overall profitability. If you're not fully aware of these costs, they can quickly eat into your returns and leave you with unexpected expenses. That’s why understanding these numbers is essential to managing the long-term financial commitments of owning a property.

At Providence, we use various metrics to evaluate potential investments and track the total holding costs over the life of the investment. These metrics provide a clearer picture of a property's ability to generate revenue and profit, allowing us to assess the overall risk and return on investment. Among the most important metrics are Internal Rate of Return (IRR), Gross Yield, Net Yield, Pre-Tax Cash Flow and Post-Tax Cash Flow.

IRR – Internal Rate of Return

The Internal Rate of Return (IRR) is one of the key metrics we use to evaluate an investment property's performance. It calculates the rate of return on a series of cash flows over time, factoring in the time value of money. In simple terms, think of the money you are outlaying on your investment property as being deposited in a bank account, with interest added each year.

Let’s break it down with an example. Suppose you purchase a property for $200,000 and expect to receive the following after-tax cash flows over the next five years:

• Year 1: $10,000

• Year 2: $12,000

• Year 3: $14,000

• Year 4: $16,000

• Year 5: $18,000

At the end of Year 5, you plan to sell the property for $250,000.

To calculate the IRR, you need to find the discount rate that makes the net present value (NPV) of these cash flows equal to zero. Essentially, you're calculating the rate that ensures the sum of the present values of the cash flows and the sale price equals your initial investment of $200,000. If the IRR is 10%, it means your investment is expected to generate an annual return of 10% over five years.

The higher the IRR, the better the investment. That’s why it’s important to carefully calculate the IRR over the entire investment term. Using available IRR calculation tools can help you assess whether a property is likely to generate the kind of return you're aiming for.

By considering metrics like IRR, investors can minimise risk and maximise profit. These tools allow you to see the full financial picture, including how much income you can expect to generate over time and the eventual return on your investment.

Gross Yield, Net Yield, Pre-Tax & Post-Tax Cash Flow

Other important metrics to consider when evaluating an investment property include Gross Yield, Net Yield, Pre-Tax Cash Flow, and Post-Tax Cash Flow.

• Gross Yield provides a snapshot of your property’s return based purely on rental income before expenses.

• Net Yield gives a more accurate view of the actual return on investment by factoring in costs such as property management fees, maintenance, insurance, and taxes.

Pre-Tax and Post-Tax Cash Flow are also crucial for understanding your property's profitability:

• Pre-Tax Cash Flow reflects the property's cash flow before income tax is accounted for.

• Post-Tax Cash Flow shows the amount of money you can expect after tax has been deducted.

Both are important for determining whether your property will provide positive cash flow or if you'll need to use other funds to cover holding costs.

Final Thoughts

A successful property investment is not just about finding the right property—it’s about understanding the financials behind it and ensuring you're fully prepared for the costs involved over the long term. Always know your numbers and make data-driven decisions that set you up for success.