If you are investing in a property for the first time, a lot of the terms associated with the property sector can be quite confusing. If you would like to read on, hopefully some of these terms can be simplified enough to clarify any situation you might be in, and hopefully educate any future scenarios you may be in.
Cash yield is calculated by taking the annual before tax cash flow of a property, and dividing that number by the total cash invested. This will then give you a greater sense of how much return on cash you received from your different property investments. For example, if you put down $250,000 as a down payment in cash, and also spent $50,000 in repairs, you would have the sum of the total cash invested be $300,000. Then you would take the rental income before tax, and in this example it would be $36,000. You then divide $36,000 by $300,000, and your cash yield would equal 0.12 or 12%. Be aware that cash yield doesn’t consider aspects like tax benefits or appreciation, but it is a good tool to compare the profitability of different investments, even more so if this is your first year of property ownership.
Capital gain is calculated by taking the difference of what you paid for the property and what you sell it for minus expenses. To get a better estimate of the capital gain of the property, consider the adjusted sale price which is the sale price of the property minus the fees like the realtor’s commissions, and perhaps fees for advertising if you did so. Then consider the adjusted purchase price by using the purchase price and subtracting ownerships fees such as repairs or stamp duty. Now, take both of those estimates and subtract the adjusted purchase price from the adjusted sale price. If you are not sure of your calculation, or you felt like you left out some fees, ask your accountant for advice to get a more accurate figure.
You might have heard of gearing before, which is defined by borrowing money for an investment. However, negative gearing is when the costs of owning a property are greater than the income the property is taking in. This may seem like a nightmare situation, yet negative gearing can actually give the investor a tax break, while waiting for the market to work in the property’s favour and appreciate in value over time.
The opposite of negative gearing, this is when the property is generating more income than expenses of owning. Although generally a good thing, this also means that the investor will have to pay higher taxes on a higher income from the property. Overall, this means that you are making a return on your investment, which in the end is what everyone wants.
This term refers to the practice of using more than one property to secure one loan or more. This could happen if you currently have a home, but would like to buy a second one as an investment, and you need a considerable loan to finance the investment. To proceed with the loan, the bank can cross-collateralise the against your home and the other property, so that in case of situation where payments aren’t being made, one or both of the properties can be used as collateral. This type of practice can be good if you are in need of a large loan, but it comes with high risk, so many advise against doing so.
Hopefully going through these simplified terms has alleviated you of any confusion, and you are on your way of making better financial choices for your investment property.