Is your investment property doing as well as it could? I’ll get straight to the point. If you’re focussing on ROI, take a look at ROCE (row-key). It tells you lots more and might even help with whether to hold or sell.
Check out this podcast on the same topic. BiggerPockets agrees with me Better than ROI
What Get Measured Gets Managed
You’ve heard the phrase ‘You Get What You Measure’ and ‘What Gets Measured Gets Managed’. They’re both true. Very true. So you need to measure the right thing.
Be Careful Not To Measure The Wrong Thing
Investment property is all about sweating the asset. Choosing the right metric is where things can go wrong. You probably know that cash flow is important. You’re right, it is. Possibly the most important thing. You’ve probably also heard that ROI (Return On Investment) is important. Especially if – like me – you’re a No Money Left In (NMLI) investor. Infinite return and all that. It’s a great target and hitting it makes you feel good. And even if you miss the Holy Grail of completely 100% NMLI, returns of 30% or 40% are great.
Is There Anything Better Than ROI For Your Investment Property?
So here’s the thing. The money you put into an investment property is important … the deposit helps you buy it, you need a bit extra for costs, and probably some more for a refurb too. If you can pay for all that and get all that money back, and still own the property, and have it pay you each month, then you’re winning. You’re definitely winning. 100%. But maybe you could be doing even better. If you approach the question from a slightly different angle there’s a whole new world to explore.
Cashflow Is King But ROCE Rules Them All
Cashflow is King, but ROCE rules them all. Return On Capital Employed. What we want to know, what’s really important, is how hard each £ is working (you’ve heard the phrase every £ is a prisoner).
Once you own the property and it’s up and running (after you’ve added value), measure the income it gives you against the money that’s locked up in the property, the equity (also called capital employed).
That’s different from how much money you’ve got left in your initial investment. (Of course, it makes sense to look at both, but stick with me and see if you think it’s worth looking at how hard those prisoners are working). Once you’ve bought it, refurbed it, and rented it out, then it’s yours and so maybe it’s not all about the cash bit. What’s important is how much of the value you’ve created is working and how hard it’s working. The capital employed (or to put it in terms us property investors are more used to, equity).
Simple To Calculate
Take your net profit over a year (after all costs, including everything) and divide that by the capital employed (equity) you’ve got in the property (the value of the property minus the mortgage amount). The simplest way to think about this is ‘What would I get if I sold?’.
And just in case some of you are worrying about other costs, should I include any redemption charges? What about taxes? Should I account for capital gains? These are all important, and before you take a big step like selling, please include them.
Before you get that far, try these headline numbers. They’ll tell you a fascinating tale all by themselves. The point of this metric is to tell you if the bit of the property that you own – your ‘cash bit’ – is working hard enough. It’s a starting point for making sure that every £ is a soldier (or prisoner). It’s not the endpoint for deciding if you should sell. If you’re heading that way, add in tax, fees, and costs, but don’t do that too early and lose heart down in the details. Use the headline figures. They’re more than enough to get going.
Let’s get to an example. This is from my portfolio, a 1-bed flat in Southampton. By the end of this article, you’ll see where the ROCE has taken me and what I’ve decided to do with it.
Property Investing Is Not All About The ROI
Right now you’ll probably be thinking about the cash. Your cash. Especially if you’ve refurbed and re-financed and you’ve managed to get some money out. If that’s your strategy, you’re probably really focused on the cash. I always was. And that’s understandable. That tells you the ROI. But I promise you, a whole new world of clarity will open up if you look at the capital employed.
Of course, cash left in is still important. But it’s not the only thing. You’ve bought it, it’s making money and there’s equity in it. Great. And now that it’s yours, you can’t really change what’s happened. As a wise friend used to say to me ‘It is what it is.’ The important numbers now are the annual profit (net of costs) and the equity. Whether you invested £20k or £50k or nothing initially, doesn’t affect how well it performs now.
What About Capital Growth?
So far we’ve talked about the return from rent. Let’s call that R-ROCE
Now do the same calculation for the capital growth in the last year. This is the C-ROCE.
Use the last 12m actual increase in value so it’s a real figure you can trust.
This is the amount the property has gone up in value over the last 12 months, divided by the capital employed.
My example doesn’t look too good:
How Do I Know If My ROCE IS Good?
So you’ve got a percentage for R-ROCE and a percentage for C-ROCE.
Your R-ROCE might be 5% or 10%, or if you’re doing very well 20%. Right now, my R-ROCE figures for each property are between 3.4% and 11.3%. The average is 5.4%.
My C-ROCE range is 0% – 40%. The example above is the low 0%. It’s not a great investment flat and never was. A mistake. And the 40% is also an outlier. My average across the portfolio is 15.2%.
Now, add up the R-ROCE and C-ROCE for each property to give you an overall total ROCE or T-ROCE.
Use the actual R-ROCE and C-ROCE for each property to get a T-ROCE for each one.
Now we can make some decisions.
The R-ROCE is the bit that pays you regularly right now. It feeds you.
The C-ROCE doesn’t feed you but it makes you wealthy in the long run.
You need a balance. Or some that are strong on the rental side, and others on the capital side.
The T-ROCE is what tells you overall how well that property is performing.
So What Is A Good ROCE?
Of course there’s lots of answers. I aim for an R-ROCE of 10% or more. That’s hard to find and 6%-8% would be fine if there’s something else, some other benefit the property’s got. If I can hit 10% I reckon that’s really good. My average is 5.4% so well behind what I would buy now as replacement. The property has gone up in value faster than the rent so that makes sense. Over time, the capital goes up and so when the C-ROCE is doing well, that brings down the R-ROCE.
On C-ROCE, it’s harder to have a target. But it’s very useful to see how it’s performing. If it’s doing well, then a poor R-ROCE doesn’t matter as much. And you might watch it for future years of strong growth. Tracking them both over time really helps to see what to hold and what to sell. A property might have gone up in value but then stalled, and the figures start to trend down.
My T-ROCE overall is 20.6%. 5.4% + 15.2% And that feels like it’s worth having. It’s not stellar, but I’ll take it.
And my lowest performing property is the example 8.2% + 0% = 8.2% T-ROCE
It’s been low for years. So it’s time to move this one on. I’ve given notice to the tenant. We get the keys this week. After a quick spruce up, I”ll put it on the market for sale. I’ll pay some SDLT but even after that, I’ll replace it with something that’s better performing. It should match the R-ROCE or beat it. And I reckon I should easily do better than 0% capital growth.
Investing in property can change your financial future. If you want any more help with this, check out my mentoring programme Mentoring with Rob
