Yield to maturity (YTM) is a calculated rate of return generally used when investing in bonds, but can also be used when investing in real estate. Yield to maturity analyzes the rate of return for the investor on an annual basis shown as a percentage rate, assuming they hold the investment to its maturity. It takes into account the current and future value of the asset and determines the overall yield in relation. In real estate, yield to maturity is most commonly used when investing in mortgage notes or real estate debt.
Yield to Maturity Formula
YTM can be calculated by hand using a formula, but unless you are well versed in solving complex mathematical equations, using a 10bii calculator or excel formula may be a more straightforward option. You can download a 10bii calculator straight to your smartphone from the App Store or Play Store.
There are several vital variables in helping calculate yield to maturity in real estate.
- The time (N) the investment will be or is held, typically shown in months.
- The interest rate/yield (I/YR) you want to achieve or the actual rate you are charging on the mortgage note. When solving for yield to maturity, the I/YR is the YTM.
- The present value (PV) in most cases, how much you invested (shown as a negative number on a 10bii calculator).
- Any payments (PMTS) received over the investment period.
- The future value (FV) which is the value of the investment is at maturity or payoff.
Real estate mortgage notes are depreciating assets. Regardless of whether you buy a pre-existing mortgage note at a discount or create one yourself using owner financing or private lending, every payment the borrower makes, the value of the mortgage note decreases. When it comes to analyzing your investment and return, this decreasing future value needs to be taken into consideration.
How to use yield to maturity in real estate
Let's think about this in a real example. Let’s say you created a mortgage note on a single-family property you are selling for $150,000. You found a great buyer that had a $20,000 down payment and you offered to carry the financing for the remaining $130,000 at an 8% interest rate for 30 years (360 months). This is a fixed-rate mortgage, so with each $953.89 principal and interest payment the borrower makes, the principal is reduced. Eventually, after 30 years have passed, the future value of the note will be zero and the loan will be paid in full. In this example, the yield to maturity is equal to the interest rate being charged (8%). If you held the note to its maturity, you would receive an 8% annualized rate of return over that 30 year period.
Now, let’s say you didn’t create this mortgage note, but instead bought it at a discount. Let’s determine what your yield to maturity would be then.
The borrower has paid on this note for 10 years and there are currently 240 months remaining on the note. The current balance is $114,042.84 and the principal and interest payment remains the same, at $953.89. You negotiate a discounted purchase price of $98,846 for the note, which equates to a 10% annualized YTM assuming you held the note for the remaining time, 240 months. The greater the discount in the purchase price, the higher the yield to maturity.
Let’s look at one more example of calculating yield to maturity where you would sell the original mortgage we used in the first example at a discount to the buyer in example two. Since you sold the loan after 10 years (120 payments) and found a buyer that is willing to pay $98,846.90 for the note, you would adjust your future value to the cash you receive for selling the note at month 120.
The overall YTM is reduced to 7.16% from the original 8% YTM. The loan was held for a shorter period of time than originally intended and the discounted rate or future value equated to a slightly lower return overall.
Yield to maturity in summary
Yield to maturity is arguably the best return calculation to compare varying investment opportunities when the real estate asset depreciates or decreases in value over time. It provides a more realistic rate of return of the cash flow and investment over a set period of time. To calculate returns on simpler forms of cash flowing real estate investments like a single-family rental, cash on cash (CoC) or internal rate of return (IRR) may be a better tool.