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What are the calculations used to evaluate property investment opportunities?

To choose an investment property with your heart but not your head is not investing, it’s financial suicide.

A characteristic of successful investors is the ability to remove themselves from a situation and be able to look at an opportunity objectively.

Most investors use a few calculations or gauges which they have learned to trust over time. These can be different for each investor and there are arguments for and against certain calculations.

 

 

Calculations should typically be done before viewing a property.

 

In this article I will share the ones I would typically use and why I use them.


1. Gross Rental Yield

This is an equation which takes the gross yearly rent and divides by the total purchase price of the property, expressed as a percentage.

This equation is great when you are comparing properties and you know the variables (such as loan-to-value, interest rates and expenses, etc.) will be similar.

It is a quick litmus test comparing properties.


2. CAGR over 5 years

CAGR (Compound Annual Growth Rate) is a simple way to compare the investment to other opportunities.  It is better than total ROI because it calculates with the number of years you hold the investment.

Banks typically offer 1 to 3% compounding interest rates on savings. Sometimes it is compounded monthly, quarterly or yearly.

CAGR is a great way to measure stock returns since a stock can be up 40% one year and down 10% the next. By using a calculation over 5 years you can see the yearly return accomplished.

A CAGR of roughly 15% over 5 years will double your investment. This is very achievable with a property investment. As a comparison, with a CAGR of 3% (your money in savings at a bank) it would take you about 23 years to double your money.

CAGR for a property over 5 years can be calculated by taking the yearly net cash flow (whether negative or positive) multiplied by 5, adding the amount of principle you will pay off in 5 years on the mortgage and finally adding the expected increase in value of the property over the same period. Here is an example calculation of the CAGR of a typical Czech investment property.

To calculate the monthly mortgage payments and the amount of principle paid off over time I use a mortgage calculator. I have come to prefer the output data on this mortgage calculator (and not just because I am Canadian) as it breaks down your principle and interest payments each year.

Many property investors use the IRR (Internal Rate of Return) calculation for a property which is essentially what I do above. Although in my personal calculations I don’t include transaction costs since all investments have transaction costs and you will likely hold the property longer than 5 years.

Many IRR calculations also include taxes. I normally don’t include taxes because it can greatly complicate the equation if you start to work with depreciation and other tax deductions. It means you need your accountant involved. Suffice to say that property has a huge tax advantage over other investments.

Here is a simple CAGR calculator where you input your starting and ending values and the number of periods it compounded over.


Cash on cash

Investors looking primarily for cash flow use this metric.

It is a simple calculation of the total net cash return the investment will give (before tax) compared to the amount of cash you put in, expressed as a percentage.

The calculation is: cash-on-cash return = annual before-tax net cash flow / total cash invested.

Like the gross investment yield this has been considered a great napkin test of whether an investment merits further consideration or not. A higher than average percentage can indicate that the property is underpriced.

A note of caution – this calculation does not take into consideration appreciation / depreciation of the asset or the amount of principle which is being paid off when a mortgage is involved.


Whenever making calculations it is good to work with a best case, worst case and most likely case scenario. This helps you to see if you could financially handle, for example, mortgage interest rates going up 2%, an extended vacancy or other variations. 


by Nathan Brown - nathan@czechpoint101.com - owner and managing director of Czech Point 101  - "You’re in good hands whether buying, selling or managing property in the Czech Republic."   

 
 
 
 
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