ROI and ROCE: Why the Same Property Shows Two Very Different Returns
Summary
- Return on investment (ROI) is a broad term. It is not meaningful unless the denominator, period, finance treatment and tax treatment are stated.
- Yield is also a family of measures. Gross yield, net yield, yield on cost, reversionary yield and equivalent yield each use a different income figure and a different denominator.
- Return on capital employed (ROCE) measures operating profit against the total capital used in the asset. It is normally calculated before finance costs.
- Return on equity is affected by borrowing. More debt can increase the percentage return on the investor’s own money, but it also increases exposure to interest costs and refinancing risk.
- The same illustrative property can show 11.00 per cent on the deposit, 9.31 per cent on total equity employed and approximately 6.93 per cent ROCE. All three figures can be arithmetically correct.
- ROCE should be calculated first because it tests the asset rather than the funding structure.
- Commercial shops and residential upper parts must be modelled separately. They should not be blended into one yield without showing the underlying assumptions.
- Capital is at risk. Income and returns are not guaranteed.
Why ROI alone is incomplete
A percentage without a stated basis is not enough information.
When an investor is shown a return figure, ask:
- Return on what?
- Over what period?
- Before or after finance costs?
- Before or after tax?
The denominator may be:
- The purchase price.
- The deposit only.
- The deposit plus stamp duty land tax, legal and survey fees.
- Total equity employed, including capital expenditure.
- Total capital employed, including both debt and equity.
The numerator also needs definition. It may be gross tenant rent payments, net operating income, cash flow after finance, profit after tax or total profit including a capital gain. These are different measures.
A quoted “15 per cent ROI” does not explain which of these has been used. It may be accurate on the deposit and unhelpful for judging the building.
The main property return measures
Gross yield
Gross yield is gross annual tenant rent payments divided by the purchase price.
For example:
£75,000 annual tenant rent payments ÷ £1,000,000 purchase price = 7.50 per cent gross yield.
Gross yield ignores:
- Finance costs.
- Repairs and maintenance.
- Insurance.
- Voids.
- Unrecovered service costs.
- Capital expenditure.
- Tax.
- Acquisition costs.
It is useful as an initial screening measure. It is not a complete return.
Net yield
Net yield is net property income divided by the purchase price.
The income is reduced by property-level costs such as maintenance, insurance and unrecovered management costs. Finance is still excluded.
Net yield therefore tests the asset more closely than gross yield, but it still does not show the return on the investor’s cash.
Yield on cost
Yield on cost divides net property income by the total capital cost, meaning the purchase price plus acquisition costs plus any capital expenditure.
Net property income ÷ total capital cost.
Where a property has been bought and works have been carried out, yield on cost is usually the first yield measure at which the asset and the works are both reflected in the denominator. It is therefore closer to a true asset measure than a yield calculated on the purchase price alone.
Reversionary yield
Reversionary yield uses the estimated rental value rather than the current passing rent, divided by the current capital value.
Estimated rental value ÷ current capital value.
It shows the yield the asset would produce if the income were at market level. It is a measure of potential, not of current performance. Because it depends on an estimated rental value, it must be evidenced from comparable transactions rather than assumed. Where a unit is vacant, or let below the market tone of the parade, the reversionary yield will look higher than the passing yield. That gap is not income and it is not value until the rent is actually achieved.
Equivalent yield
Equivalent yield is the internal rate of return of a property investment expressed as a yield. It weights the passing income and the reversionary income over time, so it accounts for the fact that a portfolio of rents arrives in stages rather than all at once.
It is widely used in commercial investment valuation because it allows assets with different lease profiles to be compared on one basis. It is more sensitive to assumptions about rent growth, timing and lease events than a simple income yield, and it is normally produced by a valuer rather than calculated on a desktop.
How yield relates to capital value
Yield and capital value are two views of the same relationship. If income is held constant, a lower yield produces a higher capital value, because value is income divided by yield:
Capital value = net income ÷ yield.
That relationship is why a single leasing decision can move a valuation more than a small rent increase can, and why the durability of the income matters as much as the amount of it. It is also why Realty Packaging models the commercial shop and the residential upper parts separately rather than blending them into one yield: a blended figure conceals which element is producing the income and which element is carrying the risk.
Return on equity
Return on equity is often called cash-on-cash ROI in property reports.
It is usually calculated as:
Net income after finance ÷ the investor’s equity.
The most flattering version uses the deposit only. It excludes acquisition costs and refurbishment expenditure from the denominator.
The percentage rises as borrowing rises, provided the income generated by the asset exceeds the cost of the debt. This does not mean the building has improved. It means the investor has used less of their own money.
Return on equity employed
Return on equity employed uses the full amount of the investor’s own money in the transaction.
This may include:
- The deposit.
- Stamp duty land tax.
- Legal and survey fees.
- Capital expenditure.
- Refurbishment costs.
- Other directly attributable acquisition costs.
The formula is:
Net income after finance ÷ total equity employed.
This is a more complete version of cash-on-cash return. Several earlier Realty Packaging reports used the term “true return” for this measure. That description is not a standard accounting term. In this article, it is identified as return on equity employed.
Return on capital employed
Return on capital employed (ROCE) measures operating profit before interest against the total capital used by the asset.
The property-practical formula is:
Operating profit before finance ÷ total capital employed.
Total capital employed includes the equity and debt used to fund:
- The purchase price.
- Acquisition costs.
- Capital expenditure.
ROCE is financing-neutral. Subject to using the same operating assumptions and valuation basis, it should not change merely because the property is funded with cash, a mortgage or a different ownership vehicle.
Capital employed: accounting definition and property application
The accounting definition of capital employed is:
Total assets less current liabilities.
It can also be expressed as:
Equity plus non-current liabilities.
For property analysis, the practical application is usually the total capital committed to the asset:
Purchase price plus acquisition costs plus capital expenditure, funded by any mix of equity and debt.
Both definitions should be explained whenever a figure is quoted. Consistency matters more than the label.
There is no single universal property ROI formula. Some reports use ROI to mean ROCE. Others use it to mean return on equity or a total project return. Published property figures, including some earlier Realty Packaging reports, have used “ROI”, “cash-on-cash ROI” and “true return” interchangeably while measuring different things.
A report should therefore state:
- The numerator.
- The denominator.
- Whether debt costs are included.
- Whether tax is included.
- The period.
- Whether the calculation uses historical cost, current value or another valuation basis.
- Whether capital expenditure has been included.
Worked comparison: one property, all the measures side by side
The following is an illustrative calculation. It is not a model of an actual property, forecast, valuation or promise of outcome. It shows yield measures and return measures alongside each other so the difference is visible.
Assume a building with:
- Purchase price: £1,000,000.
- Operating income before finance: £75,000 per year.
- Illustrative acquisition costs: £45,500.
- This comprises illustrative non-residential stamp duty land tax of £39,500 and a £6,000 legal and survey allowance.
The stamp duty land tax figure is illustrative and must be confirmed against the transaction, applicable rates and current guidance.
Total capital employed is therefore:
£1,000,000 + £45,500 = £1,045,500.
Buyer one: cash purchase
The buyer pays the full purchase price and acquisition costs in cash.
- Total capital employed: £1,045,500.
- Operating profit: £75,000.
- ROCE: £75,000 ÷ £1,045,500 = approximately 7.17 per cent.
- Return on equity: approximately 7.17 per cent because there is no debt.
Buyer two: 75 per cent borrowing
The buyer uses illustrative interest-only finance at 6 per cent.
- Debt: £750,000.
- Deposit: £250,000.
- Acquisition costs: £45,500.
- Total equity employed: £295,500.
- Annual interest: £45,000.
- Net income after finance: £30,000.
- Return on equity employed: £30,000 ÷ £295,500 = approximately 10.15 per cent.
- ROCE: approximately 7.17 per cent.
The ROCE has not changed. The building has not changed. The debt has changed the distribution of the operating income between the lender and the investor.
Including maintenance and insurance
Now include an illustrative annual allowance of £2,500 for maintenance and insurance.
- Operating profit: £75,000 less £2,500 = £72,500.
- ROCE: £72,500 ÷ £1,045,500 = approximately 6.93 per cent.
- Net income after finance: £72,500 less £45,000 = £27,500.
- Return on equity employed: £27,500 ÷ £295,500 = approximately 9.31 per cent.
- Deposit-only return: £27,500 ÷ £250,000 = 11.00 per cent.
The three figures are:
- 11.00 per cent on the deposit.
- 9.31 per cent on total equity employed.
- Approximately 6.93 per cent ROCE.
All three are arithmetically correct. They describe different things. Only the third is designed to measure the operating performance of the building independently of finance.
This combination is consistent with the previously published Caterham report, which quoted 11 per cent on the deposit alone. It is not a current valuation or return statement and requires independent verification.
All the measures together on the same illustration:
| Measure | Calculation | Illustrative result |
|---|---|---|
| Gross yield | £75,000 ÷ £1,000,000 | 7.50 per cent |
| Net yield | £72,500 ÷ £1,000,000 | 7.25 per cent |
| Yield on cost | £72,500 ÷ £1,045,500 | Approximately 6.93 per cent |
| Return on equity employed | £27,500 ÷ £295,500 | Approximately 9.31 per cent |
| Return on the deposit alone | £27,500 ÷ £250,000 | 11.00 per cent |
| ROCE | £72,500 ÷ £1,045,500 | Approximately 6.93 per cent |
Three points follow from the table. First, yield on cost and ROCE are numerically the same on this illustration, and that is not a coincidence: where there is no capital expenditure beyond acquisition, and where finance is excluded from both, the asset's operating income over the total capital cost is the same calculation described two ways. Second, the two yield measures that use the purchase price alone both flatter the asset relative to yield on cost, because acquisition costs are real capital and belong in the denominator. Third, only the last two rows include the effect of borrowing, and only the last one uses the deposit alone, which is the smallest denominator on the page and therefore the largest percentage.
How leverage changes the result
Hold the property and operating assumptions constant. Change only the interest rate.
| Illustrative interest rate | Interest | Net income after finance | Return on equity employed | ROCE | Gross yield |
|---|---|---|---|---|---|
| 4 per cent | £30,000 | £42,500 | Approximately 14.38 per cent | Approximately 6.93 per cent | 7.50 per cent |
| 6 per cent | £45,000 | £27,500 | Approximately 9.31 per cent | Approximately 6.93 per cent | 7.50 per cent |
| 8 per cent | £60,000 | £12,500 | Approximately 4.23 per cent | Approximately 6.93 per cent | 7.50 per cent |
Note that gross yield does not move at all across the three rows, because it uses neither the interest rate nor the capital structure. That is both its strength as a screening measure and its limitation as a measure of return.
Nothing about the building changed. Leverage amplified the existing spread between the asset’s operating return and the cost of debt.
The rule is:
Leverage improves the return on equity only when ROCE exceeds the cost of debt.
Where debt costs more than the asset earns, leverage works against the investor.
In this illustration, ROCE is approximately 6.93 per cent and the interest rate is 6 per cent. The gap is only about 0.93 percentage points. That is a thin margin.
This is why Realty Packaging treats a 7.5 per cent gross yield as a screening line rather than a target. It is not a guaranteed return and it does not replace full due diligence.
Realty Packaging’s screening thresholds
Realty Packaging uses two screening measures:
- A 7.5 per cent gross yield.
- A 12 per cent return on the deposit at 75 per cent loan-to-value using 6 per cent interest-only finance.
The simplified relationship is:
Four times the gross yield less 18 per cent.
The 18 per cent represents 75 per cent borrowing at 6 per cent:
75 per cent × 6 per cent = 4.5 per cent of the purchase price.
As a percentage of the 25 per cent deposit:
4.5 per cent ÷ 25 per cent = 18 per cent.
Therefore:
4 × 7.5 per cent − 18 per cent = approximately 12 per cent.
This is a screening rule. It is calculated on the deposit alone. It is a deposit-level measure, not a ROCE measure. Acquisition costs, voids, tax, capital expenditure and operating costs can reduce the result.
This is why the 7.5 per cent figure is used as a gross yield screen rather than as a forecast: it is a quick test on the headline relationship between price and income, and every measure in this article that includes costs, works or finance will produce a lower number than the gross yield on the purchase price.
What ROCE can reveal
A deposit-based ROI can look strong while the asset itself is producing a thin return.
ROCE helps test:
- The price paid against evidenced tenant rent payments.
- Void assumptions.
- Unrecovered service costs.
- Repairs and insurance.
- Capital expenditure.
- Energy performance works.
- Building compliance.
- The durability of the commercial income.
- The separate performance of the shop and the residential upper parts.
A mixed-use building should be modelled in separate parts:
- The commercial shop should include its own tenant rent payments, lease terms, void assumptions, repair obligations, business rates exposure and compliance costs.
- The residential upper parts should include their own tenant rent payments, letting costs, void assumptions, refurbishment requirements and applicable tenancy rules.
Forward planning for privately rented homes should use the EPC C-equivalent standard as the energy-efficiency target. Residential assumptions should also be reviewed against the Renters’ Rights Act 2025 and current requirements.
A return based on an assumed income, an uncosted building and an unverified planning position is not a return. It is an assumption.
Any Gross Development Value or residual land value should be treated as hypothetical unless supported by planning, design, cost plans, finance terms and comparable evidence.
Common errors
- Quoting a return without stating the denominator.
- Comparing a pre-finance figure with a post-finance figure.
- Leaving out stamp duty land tax, legal fees, survey costs and refurbishment costs.
- Mixing gross income and net income in the same ratio.
- Ignoring voids or treating them as temporary without evidence.
- Comparing a total return over five years with an annual income return.
- Failing to state the period.
- Assuming a higher ROI means a better asset when it may simply mean more borrowing.
- Using a ROCE figure that excludes capital expenditure the asset required.
- Comparing a pre-tax figure with a post-tax figure.
- Blending the commercial shop and residential upper parts into one yield.
- Treating planning potential as completed value.
- Treating capital allowances as an automatic tax saving.
Previously published Realty Packaging figures
The following figures are repeated only to explain the measure used in earlier reports. They are previously published illustrative figures, not current statements. Each requires independent verification.
| Earlier report | Previously published measure | What the calculation represents |
|---|---|---|
| 154 High Street, Orpington | 15.79 per cent “true return” | £34,350 net annual income after finance ÷ £217,500 total cash invested. The cash invested comprised a £137,500 deposit, £17,000 illustrative stamp duty land tax, £3,000 legal and fees, and a £60,000 refurbishment budget. This is return on equity employed. On the deposit alone, the same figures produce approximately 24.98 per cent. Gross yield on the £550,000 price is approximately 10.75 per cent. |
| 19 Station Avenue, Caterham | 11 per cent cash-on-cash return | £27,500 net annual income ÷ £250,000 deposit. On total equity employed of £295,500, the same income is approximately 9.31 per cent. ROCE on the same assumptions is approximately 6.93 per cent. |
| 141 London Road, Norbiton | 8.16 per cent current cash return | £20,400 net income ÷ £250,000 deposit. The previously published gross yield was approximately 6.54 per cent on the £1,000,000 price. |
| Lee High Road, Lewisham | 15.23 per cent on deposit | £24,750 income after finance ÷ £162,500 deposit. That figure is gross income less illustrative interest only, so it excludes acquisition costs and property costs. The same illustration stated approximately 11.80 per cent on total capital employed of £188,500, being a £162,500 deposit plus illustrative stamp duty land tax of £22,000 plus a £4,000 legal and survey allowance, after a £2,500 allowance for maintenance and insurance: £22,250 ÷ £188,500 = approximately 11.80 per cent. On the £650,000 asking price, the stated £54,000 of gross income is a gross yield of approximately 8.31 per cent. |
Where an earlier report used the label “true return”, it was measuring return on equity employed. That is a legitimate description of the calculation but not a standard ROCE definition. This article is intended to settle the terminology rather than restate the earlier figures as current.
Where ROCE stops being enough
ROCE is useful but limited.
It:
- Ignores capital structure.
- Does not show whether borrowing is sensible.
- Does not measure the time value of money.
- May use one year or a stabilised year.
- Does not capture a development profile where costs arise before income.
- Can be affected by the chosen valuation basis and treatment of capital expenditure.
Where cash flows vary over the life of a project, internal rate of return should be considered. Internal rate of return is a discounted measure that considers the timing of cash flows. It has its own assumptions and can be sensitive to the entry price, exit value, timing and finance structure. It is not a promise of outcome.
The period also matters. Assume the same illustrative total profit of £120,000:
- Earned over three years, the simple average is £40,000 per year.
- Earned over eight years, the simple average is £15,000 per year.
If the capital base is £1,000,000, those simple annual returns are 4 per cent and 1.5 per cent respectively. A total profit figure without a period can therefore mislead.
Ownership structures, capital allowances and tax-aware strategies
The after-tax position can change the return on equity. It does not change the pre-finance ROCE calculation.
A limited company is a separate legal entity. Subject to the applicable rules, it may allow profits to be retained for reinvestment and may allow mortgage interest to be deducted before corporation tax is calculated.
An LLP is generally tax transparent. Profits are allocated to its members and taxed according to their circumstances. An LLP can suit some joint investment arrangements, but it does not create an automatic tax advantage.
Capital allowances may be available on qualifying plant and machinery and integral features. These can include certain electrical, heating, ventilation and building systems. The treatment depends on the asset, transaction documents, historic claims and the nature of the works.
A Section 198 election is normally required to preserve the ability to claim qualifying allowances on second-hand fixtures acquired with a property. The seller and buyer must agree the relevant apportionment within the applicable period. HM Revenue & Customs guidance confirms that the previous owner’s expenditure generally needs to have been pooled and that the fixed value requirements must be satisfied.
A Section 198 election does not guarantee an allowance. The expenditure, fixture and use of the asset must qualify.
No ownership structure creates an automatic tax advantage. Realty Packaging does not provide tax advice. Independent tax and legal advice is required before selecting a structure or relying on capital allowances.
The Four Pillars applied to return analysis
Each of Realty Packaging’s Four Pillars changes the inputs to a return calculation:
- Lease structures: Determine the tenant rent payments, review pattern, repair obligations, breaks and income durability.
- Planning: Determines whether additional value may be achievable or is only hypothetical.
- Building condition: Determines the capital expenditure, maintenance and energy works required.
- Operational compliance: Affects cost, lettability, insurance and the ability to maintain income.
The Realty Packaging approach sets out how these issues are reviewed before an opportunity is packaged. Investors can also submit their requirements through the investment criteria page.
Practical checklist and investor action plan
Before accepting a return figure, ask:
- What is the numerator?
- What is the denominator?
- Does the denominator include acquisition costs and capital expenditure?
- Is the income gross, net, after finance or after tax?
- What period does the figure cover?
- Are the figures actual, evidenced, estimated or hypothetical?
- Are the commercial and residential elements shown separately?
- Have voids, repairs, insurance and compliance costs been included?
- Does the property meet or have a plan to reach the EPC C-equivalent standard for privately rented homes?
- Is the finance rate fixed, variable or assumed?
- Does ROCE exceed the cost of debt by a sufficient margin?
- Have planning, lease, condition and operational assumptions been independently verified?
The order of analysis should be:
- Calculate ROCE first.
- Check the cost of debt against ROCE.
- Calculate return on equity employed.
- Review the deposit-only figure last.
- Treat the deposit-only figure as the most flattering and least informative of the three.
Compliance and trust
This article is general information only. Realty Packaging does not claim to be regulated or authorised and does not claim professional registration, ombudsman membership or accreditation.
The article is not financial, tax, legal, planning, valuation, mortgage, building-survey, insurance or investment advice. It is not an offer, valuation, recommendation or invitation to treat.
Availability, price, tenancy, tenant rent payments, income, condition, finance terms, planning status, consents and costs are unverified unless expressly supported by independent evidence. Illustrative figures are not projections, forecasts or promises.
Capital is at risk. Income and returns are not guaranteed. Independent professional advice and verification are required before making a decision, committing capital, exchanging contracts or completing a transaction.
Sources
- HMRC: Examining accounts and return on capital
- Open University: Return on capital employed
- HMRC: Plant and machinery allowances on fixtures when there is a change of ownership
- Capital Allowances Act 2001, Section 198
- Realty Packaging: Our approach
- Realty Packaging: Investor criteria
For questions or support, contact support@realtypackaging.co.uk, Rachel on +44 20 4513 2218 or visit https://www.realtypackaging.co.uk.