Buy-to-let investors

Buy-to-let-ers are more focused on rental income and the cost of finance, as it is the difference between these that determines this investor's profit. Let's say they buy a unit for R300 000 from a developer and secure a tenant for R2200. If the cost of finance is R2700 per month and the levy (sectional title unit) is R500 the investor must be prepared to carry the unit to the tune of R1000 per month until rentals escalate by approximately 30% before they break even and then move into profit territory.

These investors often use rental yields as a measure of profitability or is this instance possible future profitability. R2200 / R 300 000 gives us a rental yield of 0.73% per month or 8.8% in the first year. If we assume a 10% increase in rental income the next year would return a yield of 9.68%. Sometimes the nett income is used instead of the gross income as above. Here the levy would also be worked into the calculation return a much lower yield, although that is a better reflection of the cash implications.

The rental yield example above does not use the cost of finance in the equation and is independent of interest rates or amount of equity in the property.

As an investor that focuses on cash flow this investor could opt to put a deposit of R100 000 down which would reduce the repayments and bring the cash flow to a neutral position from the outset. This doesn't change the rental yield calculations at all.

Long-term investors
Longer-term investors often use a combination of the cash flow and capital growth and cost of ownership approach. This enables these investors to pick what rental yields that they are willing to invest in, how big a deposit they want to use and how quickly the capital growth of the property will enable them to re-finance the property.

These types of investors are normally more patient with a longer horizon then the above two. IRR is a good measure of what these investors use to determine the viability of investing in a particular property. E.g. As in the first example, purchases a property off plan for R300 000 with a R5 000 deposit (which is returned on transfer with a 100% bond), secure a tenant at R2200 and levies of R500. Assuming a capital growth of 12 % the IRR would be R1 000*12 months as ratio to the 12% growth in equity = 36 000 / 12 000 or a 300% IRR.

Mix and match
As times change an investor might change their strategy from a buy-to-let to a buy-to-let and then a renovator at the point of re-selling to maximize their return. Or a buy-to-let investor might decide to carry the shortfall on a property when there has been good capital growth in a property but not good rental growth. The speculator and renovator have less room to adapt their strategy as they are working within a relatively short time frame.

Conclusion
Depending on your strategy it shouldn't matter if the market value is way less than the income value, e.g. the market value of the property is R300 000 while generating a R4000 per month income.

Some investors won't care if the income value of the property is nil while they are seeking capital growth, e.g. a stand in a plush golfing estate.

There is a difference between value and price, bank value and market value, market value and real value, income and growth value. Investors should learn the differences and adapt strategies accordingly.

Article by: Dave Welmans - (www.thepropertygame.co.za)