Property as an Investment - Part III

I've looked at your home and investment properties over the last two weeks and this week I'd like to tackle valuing investment properties. There are many different ways of trying to determine the value of a property; price, sales income, cost of ownership, future capital growth, rental income. With these various methods of valuation are a myriad of ratio's that can be used; yield, price to earning ratio, Internal Rate of Return (IRR), cap rate, capital growth rate. Today I'm going to look at some of these.

There are two main areas from which to derive a profit from these investments: Income or capital growth but tightly linked with this is the cost of ownership/finance. There are also other factors like risk, tax efficiency and management effort that could influence your strategy.

Speculators
How you value a property is often a factor of your investment strategy. Speculators are interested in price. The price they pay and the price they can realise when they sell. So this type of investor is particularly dependant on capital growth. Speculators are also concerned about the size of the deposit to hold this property until sold as this has a direct impact on cash flow.

A speculator might put a R5 000 deposit to secure an off-plan unit in a development and then on-sell the unit before taking occupation. Simplistically, if the speculator sells the unit for R20 000 more than they committed to pay for it, they have made a R15 000 profit. I'm leaving out the complexities of tax and other costs inherent in this type of short-term finance. The R5 000 turns into R20 000 over a few months, i.e. a 400% ROI.

Valuing: Speculators are focused on the price that they think that they can achieve at time of resale. Purchasing a unit at a discount from the developer at a pre-launch stage helps in this aim. Sometimes developers sell the initial units or phase at a very attractive discounted price. If the development is a large one with many phases, purchasing in an early phase and then selling at similar prices to later phases is a strategy to realize a profit. These later stages that sell at higher prices also help peg a market value for their unit.

Renovators
Renovators or fix-er-uppers will look at buying a small or run down property, investing substantially in the property and then re-selling at a profit. E.g. Purchase a property for R600 000, spent R300 000 on renovating and then re-sell at R1.5 Million.

Similarly to the speculator, this type of investor is focused on price. Buying price, selling price and price of renovations. Time is also of the essence to these investors, as the cost of holding the property will quickly erode their profit margin.

Valuation: These renovators are extremely focused on purchasing price, length that they need to hold the property while they renovate and the estimated selling price. In some rare instances the renovator can sell the property before they start renovating.

As in the speculator above the selling price is the value of the property. A comprehensive CMA or Comparative Market Analysis will help determine the price of the property. Using a per meter cost of property in the area is also a fairly good way to determine the value of this property. If they manage to buy a dilapidated or distressed sale at lets say R4000 per meter and the going rate for property in the area is R6000 per meter then after their renovations this investor should be able to realize near the top end or higher than the going rate. A 150 square meter house bought at R600 000 (4000 per meter average) renovated for R300 000 which could add another 100 square meters to the size could well sell for R6000 x 250 = R1.5 Million.

Next week: Buy-to-let investors' property valuations.

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