How much money can you make by investing in UAE real estate? Calculating the profit.

Dubai: Investors from around the world looking to invest in real estate consider the UAE as one of the most lucrative destinations. The real estate market has become attractive to both new and seasoned investors. Experts estimate that the area offers a higher return on investment, known as return on investment or ROI, compared to many established global real estate markets.

Most entrepreneurs in the UAE are investing in Dubai as they can earn gross rental yields of 5 to 9 percent, making the city an affordable place to own real estate, estimates Marwan Al Sheikh, chief executive officer (CEO) of Medait Star Real Estate in Dubai. "On average, returns in real estate generally range from 8 to 10 percent globally. Dubai is more open to attracting investors compared to Abu Dhabi, so the percentage is different. The average rate of return in Abu Dhabi is between 4 and 6 percent annually. "

Why is understanding ROI an important part of any investment process?

ROI stands for return on investment and shows the difference in return on investment. Sheikh argues that ROI is important in determining how productively and efficiently capital is used to increase profits. "It gives you knowledge or an idea, once calculated, whether an investment is a potential asset or liability, whether it's going to be a profit or a loss. It also gives the investor a rough estimate of what type of asset is more profitable and whether it is even worth investing in. "

Brief: What is ROI in real estate?

ROI in real estate is used to estimate the annual income from an income-producing property and the final income received when the property is sold. "ROI is a useful measure of performance comparing several different investments," says chief operating officer of marketing analytics firm Property Monitor, Jeanne Joshinke. "It can be used to quickly compare investment opportunities both within and in comparison to the housing market. ROI allows you to focus on the return on your money regardless of the size of the investment. "

Each investor's expectations of ROI are different.

Yoshinke also explains that one investor's ROI expectations may differ from another's for two main factors:

• The cost of operation they choose. For example, the use or non-use of a professional property manager, the level of repairs (whether the investor is relying on paying for short-term repairs or whether they are investing in long-term replacements such as air conditioning for the villa).
• The mortgage or lending options they have available and apply for with preference. For example, they pay all cash, or they take out the maximum amount of financing possible, or they have managed to get a loan payable only in interest.

Different ways of calculating return on investment (ROI).

There are many different methods used to calculate ROI. Among them, the most common are "capitalization rate", "return on invested capital" and "internal rate of return" (IRR). An investor should know the advantages and disadvantages of each of these methods, notes Ayman Yousef, vice president of real estateagency Coldwell Banker UAE.

How to calculate net rental yield or capitalization rate?

He pointed out that net rental yield, also called capitalization rate, is the easiest way to calculate ROI when buying real estate for cash. "It is calculated by dividing a property's annual income by its total purchase price. It is a mistake to exclude here current real estate costs and total acquisition cost in the calculation, which can lead to erroneous data. "Running costs include all operating expenses such as maintenance services, repair costs, or maintenance of the property if you choose to turn it over to a management company. "The total acquisition cost is the purchase price plus all transaction costs related to the 4 percent fee from the Dubai Land Department (DLD), the 2 percent commission and any other administrative fees," he added.

FORMULA: Net rental yield is calculated using the formula: Net Rental Yield = [(Annual Rent - Annual Operating Expenses) ÷ Total Purchase Costs] x 100

Calculation Illustration: For a cash buyer looking to buy a property worth AED 1 million:

• Total purchase price = AED 1,066,280 - Here's a breakdown of it:
• Property Price = AED 1 million
• Dubai Land Department fee (4 percent of property value + AED 580 administration fee) = AED 40,580
• Realtor agency fee (usually 2 percent of the property value + 5 percent VAT) = AED 21,000
• Fiduciary management office = AED 4,200
• Non-obstructive covenant (NOC) fee for re-registration of title to real estate = AED 500
• Expected annual rent = AED 60,000
• Annual Operating Expenses = AED 12,000 - Here's a breakdown:
• Service Fees = AED 10,000
• Other operating expenses = AED 2,000

To calculate the cash-on-cash yield, divide the annual cash flow of the property by the amount of money paid to acquire it.

FORMULA: Cash payment yield is calculated using the formula: Cash Payment Yield = (Cash Payment Yield per year ÷ Amount of money invested in the property) x 100

Calculation Illustration: For a cash buyer calculating using the cash payment model:

• Property price = 1 million dirhams
• Total cash investment = AED 273,565 - Here's a breakdown:
• First installment (if 20 percent of the property value) = AED 200,000
• Dubai Land Department fee (4 percent of property value + AED 580 administration fee) = AED 40,580
• Registration fee (AED 4,000 for properties over 500,000 + 5 percent VAT) = AED 4,200
• Mortgage registration fee (0.25 percent of the loan amount + AED 10 administrative fee) = AED 2010
• Realtor agency fee (usually 2 percent of the property value + 5 percent VAT) = AED 21,000
• Bank's organization fee (0.25 per cent)Yield on cash payments = (Yield on cash payments ÷ Amount of money invested in real estate) x 100

  Therefore, the return on cash payments for a financial buyer = (AED 12,000 ÷ AED 273,565) x 100 = 4.4 percent

  Yousef added that while the net yield provides insight based on the current market, it has its limitations as it does not take into account future projected cash flows (money coming in and out of the property) and the selling price of the property at the end of the investment period (term or period). For example, there is an office lease contract with an annual growth rate of 5 percent and for the first year the rent is AED 100,000. The rent will be AED 105,000 next year and AED 110,250 thereafter.

  Investing in real estate in the UAE requires setting aside time for research and knowing how much you can finance.

  How to calculate the internal rate of return (IRR)?

  When you need to estimate variable future cash flows, the internal rate of return (IRR) method is used. "IRR is the expected average annual percentage rate of return obtained from a project or investment. This is a similar concept to the previous model, but it accounts for compound interest over time. So you're evaluating an investment opportunity over a period of time, taking into account how the value of the assets will develop over time and how much you can sell for." In general, most investors use IRR to compare different investments. "The higher the IRR, the more attractive the investment is. IRR is one of, if not the most important indicator of rental real estate profitability. "It's calculated using the IRR function in Microsoft Excel, where you enter your costs and revenues. IRR includes the future value of money and opportunity costs".

  What is the internal rate of return (IRR) and why is it important?

  The internal rate of return (IRR) is a financial metric used to evaluate the attractiveness of a particular investment opportunity. When you calculate the IRR for an investment, you are actually estimating the rate of return on that investment after accounting for all projected cash flows along with the time value of money. When choosing among several alternative investments, the investor will select the investment with the highest IRR. The main disadvantage of IRR is its strong dependence on projected cash flows, which are difficult to predict. Yousef argues that net yield is usually appropriate for finished properties when there is no change in your future cash flow. The IRR model is more reliable for getting an overall picture of all available investment opportunities, he explained.

  FORMULA: The internal rate of return (IRR) is calculated using a fairly complex Microsoft Excel function/formula for 'IRR'

  Calculation Illustration: For a financial buyer and a cash buyer according to the IRR model:

  Property value = AED 1 million

  Investment period = 10 years

  Expected sale price of the property after 10 years = AED 1,280,000

  Assumed discount rate = 7 percent (discount rate reflects risks, opportunity costs and other factors affecting the value of your investment)

  Case 1: Assume the following case where a person buys real estate with a loan (a financial buyer) and calculate what the IRR rate will be:

  Therefore, in this case, the IRR rate for the financial buyer = 11.1 percent (which is derived from a Microsoft Excel function)

  Case 2: Assume the following case where a person buys real estate with cash (cash buyers) and calculate what the IRR rate will be:

  Therefore, in this case, the IRR rate for a cash buyer = 6.4 percent (which is derived from a Microsoft Excel function)

  It can be seen from these examples that cash purchases have a lower IRR rate than financesYou can also use this same methodology to calculate and compare IRRs for different properties. The higher the IRR, the more attractive the investment is.