The Importance Of Measuring & Monitoring
Investing where you rely on your skills, expertise and experience will always – over a medium to long term – outperform speculators who rely on luck.
One skill sophisticated investors implement time and time again to drive profits higher is with careful measuring and management of their money and investments. Indeed, it is well known among the wealthy that increasing profits from savings (i.e. reducing expenses) is much quicker and easier than higher profits derived from increasing rents.
Some simple math prove the point: assuming you pay eight percent in property management fees, then for every dollar of extra net income you must first earn $1.087 cents in additional rent1 . The additional 8.7 cents is needed 1 to pay the eight percent management fee so you end up with a dollar in your pocket2.
In other words, you would have to find +8.7 percent additional rental income for every dollar of additional net revenue you want to earn.
Yet using savings to increase profits require no additional effort; a dollar saved is a dollar made (as there is no management fee component)!
The extra effort required to earn income ‘above and beyond’ is akin to climbing a ladder to get an apple at the top of the tree while there is low hanging fruit available for the picking. So why don’t more investors seek to save rather than expend effort to earn? While many investors pick up a thing or two about buying property here and there, they’ve never been taught how to properly measure and efficiently manage their money and investments.
Measuring performance does not require a degree in accounting; all that’s required is a goal for your desired income and expectations of the money going out.
The simple act of having a basic budget as a tool of accountability would place you in the top 10 percent of all investors. If you want to be in the top five percent, then all you need to do is compare your actual performance against your budget each month, then decide whether you have achieved your goal. Or if you need to, take action and recalibrate your incomings and / or outgoings.
The alternative is to buy, hold and hope that your investment performs like you hope it will and only ever get round to checking when it’s time to tally up for your annual taxes.
Could you imagine a successful multinational company operating in this ‘make it up as we go along’ way? Why should you expect superior outcomes and long term performance?
Sample Performance Review
Here’s a simple template for a buyandhold property:
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Max. rent: this is the theoretical maximum rent that could have been collected in the period.
Vacancy: this is the amount of income that will be lost due to vacancy.
Gross rent: the amount of rent less vacancy.
Management: The cost of property management associated with leasing and rental collection.
Ownership: any cost incurred to own the property, including utilities, repairs (but not capital expenditure as this should be added to the property’s value), insurance, body corporate costs etc.
Taxes: any government charges levied on home owners.
Other: any other costs that do not fit in elsewhere.
Total outgoings: the sum of all outgoings.
Net operating income: the sum of gross rent less total outgoings.
Finance: principal and interest loan repayments (principal loan repayments will be added back later to determine profit).
Cash flow: the sum of net operating income less finance costs.
Principal loan payments: the portion of principal repaid in the loan repayment must be added back as this will not be tax deductible.
Depreciation: the amount of depreciation expense. Your accountant may need to provide you this figure as there are specialised rules that vary within asset classes and country to country about what and how much can be claimed.
Change in market value: this is the amount of budgeted appreciation (or loss) in capital value expected from movements in market value.
Profit: Net cash flow + principal loan payments – depreciation – loss in market value + gain in market value.
Setting benchmarks for cash flow and profitability as well as going to the effort of comparing actual to budget each month is an excellent first step, but a few more calculations really get the job done.
Capitalisation rate (Cap rate)
The cap rate represents the asset’s return from operating (rental) activities. You can compare the return with other assets to gauge performance and to see whether your risk is being adequately compensated.
Return on equity
By using profit and current market value, you price in the impact of movements in market value. This is a particularly important calculation for investors holding property for growth.
Cash-on-cash return (cost)
The cash-on-cash return represents the ‘cash back’ return for every ‘cash down’ dollar invested in the property. This calculation considers the impact of leverage on performance.
Cash-on-cash return (FMV)
The denominator is usually purchase price, but using fair market value (less debt) would be more appropriate for assets that were refinanced.
Every investor should consider performance in the light of answering this question. Is this investment returning:
- The most money
- In the quickest time
- For the least risk
- And the lowest aggravation
If your property’s performance allows you to answer in the affirmative, then great! If not, what is unsatisfactory and what can you do about it?
Are your investing results indicative of your skills in measuring and monitoring your assets? When will your financial future be important enough for you to make the effort needed for sustainable longterm success?
If you want to be more successful with your investing, then measure and manage more, and leave less things to chance.
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