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.
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
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)