Real estate investing: Let’s do the math

Real estate investment often offers entrepreneurs and investors the opportunity to grow their money over time. 

Filipinos are joining this bandwagon because of the steady economic growth post-COVID-19, as well as the resiliency of the Philippine real estate market.

Unfortunately, many have haphazardly been enlisted into the industry without properly understanding how much they can realistically earn.  This is partly due to low financial literacy and lack of appreciation about the risks, thus making them vulnerable to making the wrong investment decision, whether it be the type of property to be purchased, or the project to spend their money on.

How should you vet a prospective investment?  Here are some of the common metrics you can utilize to determine whether to continue with the venture or not. 

Rental yield (RY). Used by buyers to ascertain whether or not to purchase a property for recurring income, RY is measured by determining rental income over the property’s purchase price, and expressed as a percentage.  Simply said, it is the money returned to you based on your acquisition cost, excluding the capital appreciation of the property.

For example, you earn P9,000 monthly rent, less five percent for rental income tax, for your apartment worth P1 million. Your annual rental yield is calculated as the total annual rent of (P9,000 monthly rent less P450 tax) multiplied by 12 months) over P1 million or 10.26 percent.

Why is it relevant to your investment? Suppose you borrowed from a bank at an interest rate of seven percent per annum, your rental yield of 10.26 percent reflected a gain of 3.26 percent, affirming your right decision to purchase the apartment.

Return on investment (ROI). Although a similar measure of profitability, it is unlike rental yield however, because ROI is calculated based on the total amount you can earn over time, but inclusive of capital appreciation. 

Let’s presume that the same apartment earns you P9,000 monthly rent, less five percent for rental income tax, for your investment of P1 million.  After one year, you decide to sell the same property at the net amount of P1.1 million.  

Your ROI is computed as follows: total annual rent of P9,000 monthly rent less P450 tax, multiplied by 12 months, plus P100,000 profit and divided by P1 million. You will get a 20.26 percent, which is higher than the rental yield. 

Internal rate of return (IRR).The IRR is a measure of forecasted investment performance or rate of return on an investment. It is used to determine if a planned purchase is worth proceeding or not.

It is the interest rate at which the net present value (NPV) of the future cash flow/investment is equal to the initial investment or purchase price. Similarly, it is the growth rate from start to the end of the investment period, and shows the value of cash or returns based on when those amounts are received (time value of money).

Let’s say that you purchased property stocks worth P40,000 that became P60,000 after a year, both IRR and ROI are at 50 percent.  However, should you keep those stocks for a period of five years, your IRR may drop to approximately 10 to 12 percent due to the varying cost of money over time, despite still having a ROI of 50 percent.

Way forward

If you find these metrics daunting, fret not. Various financial calculators are available on the web to assist you in your computations.  However, should you still have doubts, consult your business development colleague, financial adviser or professional. 

Invest wisely!

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Henry L. Yap is an Architect, Fellow of both Environmental Planning and Real Estate Management, and one of the Undersecretaries of the Department of Human Settlements and Urban Development.