How to invest in property
If you are thinking of purchasing your first investment property, or perhaps adding to your portfolio, making the right decision can be based on a bewildering number of factors. Getting just the right combination of these factors can often be the difference between purchasing a GOOD investment, and a GREAT Investment.
You really can't just rely on the old cliché of location, location, location when it comes to residential property investment. You must consider the RETURN that the investment will be giving you. Is this return satisfactory when you weigh up the RISKS involved (borrowing), and does this return outperform other alternative properties or investments?
The level of return you receive from a property investment is dictated by both its cash-flow, and its ability to generate a capital gain over the period that you own it. We New Zealanders are still lucky enough to benefit from the lack of a Capital Gains Tax, and this fact makes property investment all the more profitable for would be investors. Remember these two vital items when considering any property investment:
CASH-FLOW and CAPITAL GAIN
Example 1
Purchase Price = $275,000
Gross Rent per annum = $30,000
Yield = Gross Rent/Purchase Price
Yield = 0.1090 or 10.90%
Now 10.90% is a relatively healthy return when you compare it to what you would get if you put your money in the bank.
But this return is over simplified.
We have looked at what GROSS INCOME our property is going to generate, but that's not what is going into our pockets.
So we have considered that a return is based on both income and capital gain. We have also seen that a simple yield can be calculated by using the formula: gross rental / purchase price.
However, we know that this is oversimplified because it does not take into account expenses that are associated with owning the property.
From that rental income we have to pay insurance, rates, maintenance, and even some to the dreaded tax man. So we have to analyse our rental income in NETT, after we have paid for any expenses involved in owning the property.
Example 2
Purchase Price = $275,000
Gross Rent Per Annum = $30,000
Less
$1,500 Rates
$1,500 Insurance
$500 Maintainence
$ 1,000 Other Costs
Total Costs = $ 4,500
Net Income = $25,500
Yield = Net Income/Purchase Price
Yield = $25,500/$275,000
Yield = 0.0927 or 9.27%
You can see that our return has dropped by over 1.5% when we take into account the expenses involved in running the property.
Now this type of analysis is fine if your looking to calculate the return a property will provide within the FIRST YEAR of ownership.
But very few residential property investors will look at holding a property for just one year however. It therefore becomes necessary to be able to calculate a property's overall return after 5, 10, 15 or even 20 years.
To do this we need to consider changes in rental levels, rises in property expenses and all those other variables which change constantly over time.
The good news is that with the aid of a computer, we can carry out this detailed analysis virtually at the blink of an eye.
There is no doubt that computers have made out lives easier.
However, when assessing property returns, computers are great in that they can look at thousands of variables and provide answers in the blink of an eye - try doing that on the back of a cigarette box!
The benefit of this computer analysis is that all variables involved in owning the property can be considered, and a true reflection of the REAL RETURN can be seen.
Other important considerations when calculating a properties return include:
The time value of money - the effect of inflation eroding a dollars worth.
Likely changes in rental levels over the holding period.
Likely changes in expense levels over the holding period.
The likely capital gain over the holding period.
The rate of return that you, as an investor, wish to achieve.
All these variables can seem a bit daunting at first, but there are now established methods for calculating a properties REAL RETURN.
These methods have become even simpler and faster with the advent of computer programs. These can calculate a return in an instant, and even consider slight changes in variables such as interest rates, fees and income projections over the term of the holding period.
An example of such is included in the following picture:
Look a bit daunting?
It does when you first look at one of these programs. But after you've analysed a few properties using this method, understanding the logic and seeing the results becomes a whole lot simpler.
The benefits of this type of analysis include:
A more accurate reflection of the property's performance over time.
The ability to include tax, and to see its affect on performance
Set the return you require and see whether the property delivers
Change variables quickly and see results instantly.
Whether you are analysing the performance of a property investment within your portfolio, or using this type of program to isolate new property investments, the benefits to the property investor of this type of analysis are immense.
I hope you have enjoyed this article.
You really can't just rely on the old cliché of location, location, location when it comes to residential property investment. You must consider the RETURN that the investment will be giving you. Is this return satisfactory when you weigh up the RISKS involved (borrowing), and does this return outperform other alternative properties or investments?
The level of return you receive from a property investment is dictated by both its cash-flow, and its ability to generate a capital gain over the period that you own it. We New Zealanders are still lucky enough to benefit from the lack of a Capital Gains Tax, and this fact makes property investment all the more profitable for would be investors. Remember these two vital items when considering any property investment:
CASH-FLOW and CAPITAL GAIN
Example 1
Purchase Price = $275,000
Gross Rent per annum = $30,000
Yield = Gross Rent/Purchase Price
Yield = 0.1090 or 10.90%
Now 10.90% is a relatively healthy return when you compare it to what you would get if you put your money in the bank.
But this return is over simplified.
We have looked at what GROSS INCOME our property is going to generate, but that's not what is going into our pockets.
So we have considered that a return is based on both income and capital gain. We have also seen that a simple yield can be calculated by using the formula: gross rental / purchase price.
However, we know that this is oversimplified because it does not take into account expenses that are associated with owning the property.
From that rental income we have to pay insurance, rates, maintenance, and even some to the dreaded tax man. So we have to analyse our rental income in NETT, after we have paid for any expenses involved in owning the property.
Example 2
Purchase Price = $275,000
Gross Rent Per Annum = $30,000
Less
$1,500 Rates
$1,500 Insurance
$500 Maintainence
$ 1,000 Other Costs
Total Costs = $ 4,500
Net Income = $25,500
Yield = Net Income/Purchase Price
Yield = $25,500/$275,000
Yield = 0.0927 or 9.27%
You can see that our return has dropped by over 1.5% when we take into account the expenses involved in running the property.
Now this type of analysis is fine if your looking to calculate the return a property will provide within the FIRST YEAR of ownership.
But very few residential property investors will look at holding a property for just one year however. It therefore becomes necessary to be able to calculate a property's overall return after 5, 10, 15 or even 20 years.
To do this we need to consider changes in rental levels, rises in property expenses and all those other variables which change constantly over time.
The good news is that with the aid of a computer, we can carry out this detailed analysis virtually at the blink of an eye.
There is no doubt that computers have made out lives easier.
However, when assessing property returns, computers are great in that they can look at thousands of variables and provide answers in the blink of an eye - try doing that on the back of a cigarette box!
The benefit of this computer analysis is that all variables involved in owning the property can be considered, and a true reflection of the REAL RETURN can be seen.
Other important considerations when calculating a properties return include:
The time value of money - the effect of inflation eroding a dollars worth.
Likely changes in rental levels over the holding period.
Likely changes in expense levels over the holding period.
The likely capital gain over the holding period.
The rate of return that you, as an investor, wish to achieve.
All these variables can seem a bit daunting at first, but there are now established methods for calculating a properties REAL RETURN.
These methods have become even simpler and faster with the advent of computer programs. These can calculate a return in an instant, and even consider slight changes in variables such as interest rates, fees and income projections over the term of the holding period.
An example of such is included in the following picture:
Look a bit daunting?
It does when you first look at one of these programs. But after you've analysed a few properties using this method, understanding the logic and seeing the results becomes a whole lot simpler.
The benefits of this type of analysis include:
A more accurate reflection of the property's performance over time.
The ability to include tax, and to see its affect on performance
Set the return you require and see whether the property delivers
Change variables quickly and see results instantly.
Whether you are analysing the performance of a property investment within your portfolio, or using this type of program to isolate new property investments, the benefits to the property investor of this type of analysis are immense.
I hope you have enjoyed this article.
Next Article: How to Work out a Property's Market Value