Are you getting the most out of your investment property?
Category Investment
Choosing the right property at the right price.
Most of the Investors we work with are focused on cash flow from their asset, but an important and often overlooked component of an investment property is the capital appreciation or the increase in value over time. We all know that over time our property assets will increase in value. Some properties however will increase in value a lot faster than others. To understand this, it is important to understand that the growth in value resides primarily in the land, and not the improvements. This is the key to making good investment decisions and the reason so many agents will use the slogan “location, location, location”. Land appreciates over time and the closer the land is to a growth area or a high demand area, the better the appreciation.
Unless buildings are kept updated and maintained, they will depreciate in value over time. SARS recognises this and allows the depreciation of commercial property improvements (but not the land.) Buying an investment that includes improvements requires a capital investment over time to keep the buildings updated and in good order and condition. If you need the cash flow to make your investment work for your needs, then you must buy a property that can be tenanted.
So what is the right property? The key is to be patient and use the services of a good real estate agent to help you find a property that can be purchased at below the average market value in a growth area. A growth area is going to be in demand which will make finding a quality tenant a lot easier. A property that is on the market at less than the average price for the area is probably a smaller home or a home that is not architecturally very attractive. This may feel counter-intuitive, especially if you plan to live there and not tenant the property initially, but remember that the capital appreciation is in the land so if you buy the small two-bedroom home with the large garden next door to the large mansion with no garden in the same road, both the stands are appreciating at the same amount.
For a better understanding, let’s say you purchased the two bedroom at R1 million and your friends bought the mansion at R3 million. At the time of purchase the value of the underlying land for each property was R500,000. If the average increase in land value was 10% for the first year, that would mean that your home would be worth R1,050,000 or a capital growth on your investment of 5%. Your friend’s home would be worth R3,050,000 which would reflect a capital growth of 1.6% for the same period. To put it another way, you could buy three homes in the area at R1 million each and get a return of R150,000 in growth on your investments as opposed to buying one house at R3 million and getting back only R50,000 in capital growth.
I am often asked to source distressed property and I would like to add a caution in this regard. If you purchase on auction or a distressed property, you must take into account the costs of repair of the neglect and the requirement for maintenance or the need for eviction and any outstanding rates and levies that could become your responsibility. If this is your route to investment, you still want to try and ensure your purchase after taking into consideration all the costs involved is still at below the market average for the area.
What about apartments? The same principles apply, except in this case, the land we work with is the land the entire block is built on. A valuer looking at an apartment we had sold for a bond approval once said to me; “We never value the fittings in an apartment, a cupboard is a cupboard. It’s easy to rip them out and replace them. We value on the apartment size, its location within the block and the area where the main building is located.”
What if you improve the home? The physical structure on a property is a depreciating asset. If you left it over time, it would degrade until it loses so much value, it no longer adds any value to the land and could even have a negative value. To maintain the value in the physical structure, a cost of maintenance and updating has to be incurred. If you are renting out the property, you are going to attract better quality tenants at a higher rental if the property is well maintained.
To the best of my knowledge there are no investigations or surveys that have accurately pin-pointed the extent to which upgrades and renovations add value. Agents will give you a rule of thumb guideline that bathrooms and kitchens and decks will give a good return on a renovation, but the majority will also say “statistics tell us that you will not get back more than you spend and will most likely not get more than 70% to 80% of your cost of renovation.” I think each case has to be looked at on merit, but if you are renting out your property, you will absolutely get a premium for a home that feels modern and light with modern bathrooms and kitchen and a fashionable open plan living area. That then becomes a discussion on the amount you are willing to spend on upgrading versus your likely increase in rental.
Interestingly, the apartment where the valuer taught me a lesson in valuation had been completely refurbished with a fancy kitchen and bathroom. The valuer conceded a very small premium for the beautifully renovated bathroom and kitchen, nothing close to the actual cost of the renovation, which was also reflected in the offers we received. The only real positive was that more people were keen to view and more people were happy to make an offer to purchase, but at a premium of a maximum of 10 to 20 percent of the actual cost of the renovation! For an investor, we would probably have achieved a 10 to 20% premium in rentals. Was it worth doing such an expensive renovation? I guess the answer is not all value received is financial, there is value too in living there and enjoying it.
Author: Renee Varejes
