Hi,

This time I want to talk to you about how can avoid losing massive amounts of money, or missing out on great investment opportunities, all by understanding how to properly work out your return on investment in property

First off, let's start with a question.

What is my real return on investment for my properties?

It's a simple enough question.

Understanding the effects of cashflow timing is critical to understanding your portfolio's performance.

You can use the back of an envelope to compare sale price to purchase price and infer a return on investment, but with monthly incomes and outgoings, drawdowns, stage payments etc. it's hard to get a clear picture.

And without a clear picture you can't decide whether looking forward you should be considering property or shares or any other asset class for your investments.

So how do I calculate the return on investment for my properties?

To answer this question you need to be able to untangle the effects of upfront payments versus monthly income and outgoings, how much of the money is yours vs the banks, what the underlying growth rate in the market is etc.

The simplist tool for doing this is the Internal Rate of Return (or IRR).

It is an formula and methodology for taking into account the 'time value of money' i.e. a fancy way of accounting for the fact that a bird in the hand is worth two in next year's bush.

There are plenty of sources online that go into the mechanics and details of calculation of IRR so I won't go into that here.

All you need to know is that if you feed into this formula the full cashflow in terms of dates and amounts for an investment it will spit out a percentage. The percentage is roughly equivalent to the year-on-year growth in value of the cash you put into the investment.

So how does IRR work?

Let's start with a trivial example that you could work out on the back of an envelope.

• You pay me £100 today
• In one year I pay you £110

Your IRR is 10%. Now you probably worked that out quicker than I could type the answer.

Here's another example, still simple but closer to a property investment:

• You buy a property for £100,000, with an £80,000 mortgage
• You pay monthly interest payments at 6% for 11 months
• You sell the property for £120,000 a year after purchase
• Ignoring all the redemption penalties, agents' fees etc., what is your return?

The back of an envelope would say £20k cash in plus ~£4,400 (11*~£400) to the bank, then £40,000 out. So roughly nets £15,600 profit, which is a return of 15.6/20=~78%, or should that be 15.6/24.4 ~64% ? Errr....

The IRR formula, on the other hand, tells you that it is 72% - the effect of having to keep paying the interest over the year rather than at the end has taken about 10% of your return.

When you look at investments over several years the divergence between the back of the envelope and a proper IRR calculation becomes more marked, and with it the possibility of deluding yourself when comparing one investment to another.

So how do I calculate the IRR on my investments?

You could use Excel, but that doesn't work well unless the gaps between each payment are precisely the same.

The easiest way is, you guessed, by using the free i-PortfolioTracker.com software.

Calculating IRR using i-PortfolioTracker.com

It's simple to do, but to get it right might take you a bit of time and effort. The more information you put into the system, the more accurate your results will be. The main things you need to have entered are:

• Purchase costs (any capital payments and any extras)
• Mortgage drawdows
• Mortgage repayments
• Rental income and any related outgoings

If you go to the page for the property for which you want to calculate IRR you will see a link at the top of the page to it.

Don't forget to use the links from the main property page to add mortgage details (then any payments you log can be linked to the mortgage). Also add the rental contracts (then payments can be linked to the correct rental contract).

When you are looking at the IRR page for your property you can always add more payment information by using the log incoming and outgoing payment links at the bottom of the page.

Isn't that a bit complicated?

It's not really complicated, but if you don't put all the information in you won't get an accurate answer out, so some effort is required.

And with the margins so tight in current markets, can you afford not to run the numbers properly?

Have a go, and let me know if you have any problems. We'll be working to make the interfaces clearer and simpler to use.

Coming up next

Next week we aim to have some videos on the site showing walkthroughs of this and other things you can do with the i-PortfolioTracker.

Best wishes

Peter Bennett
Director
Visium Group Ltd

Publishers of www.propertysecrets.net & www.i-portfoliotracker.com

p.s. If you don't want to be updated on developments in i-PortfolioTracker.com you can unsubscribe from this blog at your My Account page.