Calculating investment returns

Posted On Monday, 09 June 2003 02:00 Published by eProp Commercial Property News
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Additional information on how to calculate investment returns

Jonathan SmithLast week we discussed the first step in the measurement of risk in property investment which is the measurement of the sensitivity of the investment to a change in one of the variables, such as rental fluctuations or an increase in expenses.

The second step in the measurement of risk is to calculate the standard deviation of the investment. This calculation is the range between the targeted investment return and the lowest and highest expected returns of the investment.

The lowest and highest expected returns are calculated by assessing the impact of the variables mentioned during the analysis referred to in step one of the risk measurement process.

The calculation of the standard deviation can be reduced to the following eight processes: Three to five return levels are selected by setting them out in the first column of a six-column table; The probability of each return level is entered into the second column of the table; Each return level is multiplied by its associated probability, creating a weighted probable return (at each return level) in the third column of your table; The values derived in column three are added together to derive an expected return of the investment; The expected return (derived in process four, above) is then subtracted individually from the three to five return levels (selected and entered into column one) to obtain a range of expected returns in column four of your table; The range of expected returns - entered into column four - are individually multiplied by each other (that is, squared) to remove the negative values created in column four; Each new value in column five (that is, the square of column four) is multiplied by the probability factor in column two to create a weighted expected return range in column six; and The weighted return range in column six is added together and the square root of the accumulated result of column six is calculated to derive the investment’s standard deviation. The higher the standard deviation, the more risk is attached to the property investment under review and the more cautious the property investor should be. Ways of managing or reducing risk will be explored next week.

Last modified on Monday, 26 May 2014 12:17

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