Property prices have soared over the past year, but recent closures have caused a wave of uncertainty in the market, which could be the precursor to a brief period of plateauing in property growth. price. And if you’ve already had your eye on home sales announcements for a while, this move might get you thinking about investing.

However, if you are buying a property as part of an investment strategy, there are a few additional cost factors to consider than if you were planning to live at the address.

Although the initial price you pay is important in determining the value you will get from the investment over certain periods of time, there is much more that goes into calculating the value of this type of investment.

So whether you’re looking to resell and sell or rent your property long-term, here are some things you’ll need to consider when assessing the value of your investment property.

Market Value vs Investment Value

It is important to understand the difference between these two terms as a starting point.

Market value is the price you will get for an asset – in this case, a property – in the current market reflecting current market conditions. So basically it’s the price at which a property is advertised at any given time.

Investment value is the price an investor is willing to pay to acquire an asset based on subjective objectives, criteria, or opinions. Thus, this means that if a real estate investor believes that a land or house will increase in value or provide other benefits to a point that meets his objectives, he may be willing to pay more than the market price in accordance with his calculations.

But how do you calculate what this value is, and therefore what could be the return on investment? Knowing the capitalization rate is a good way to estimate this potential, especially in terms of rental real estate.

What is a capitalization rate?

A cap rate or “cap rate” for short is a simple calculation expressed as a percentage that estimates the profitability of a property, usually in terms of annual returns. There isn’t necessarily an ideal capitalization rate because every real estate investment involves different risks and costs that can change over time, but it can be a useful way to compare this type of investment to others at all times. moment.

To determine a cap rate, you must first calculate the actual or potential net operating income of the property (i.e. the money that will come back to you). You do this by subtracting expenses such as maintenance costs, home insurance, and taxes from gross income, which is often generated by rental payments. This is expressed as follows:

Gross Income – Expenses = Net Operating Income

Then you divide the net income by the market value to produce the cap rate (you just need to convert the decimal to a percentage). It should look like this:

Net operating income / Market value = Capitalization rate

Let’s take an example. Suppose you buy an apartment as an investment property at the current market value of $550,000 and rent it out.

You charge $500 a week for rent, bringing the annual rental income to $26,000. Let’s say your cumulative operating costs add up to $8,000, which means your annual net operating income is $18,000.

Your cap rate calculation would be: 18,000 / 550,000 = 0.0327

When expressed as a percentage, this translates to an annual cap rate of 3.27%.

When you consider other properties or other types of investments like stocks or putting your money in a savings account to earn interest, then you can compare the returns of those investments (and the risks) by compared to this number.

Ongoing costs of investment properties

Wondering what some of those real estate investment expenses might be? Here are some of the main costs to consider:

  • Repairs and maintenance: If you rent your property, you will have signed a lease agreeing to organize and take charge of various maintenance tasks or emergency repairs. These can be routine or appear unexpectedly, so you will need to budget for this or consider disaster insurance.
  • Assurance: You might consider getting a landlord’s insurance policy to cover your property against storms and fires, as well as damage to tenants. Although each policy covers different events with varying limits and excludes certain circumstances, an insurance policy is generally a good back-up plan if something goes wrong and you don’t have the financial means to pay for property damage. investment or loss of rental income.
  • Property management: Some owners choose to manage a property themselves, but others hire real estate agents or property managers to handle day-to-day issues. A property manager will save you time, but naturally comes at a price.
  • Strata fees: If your investment property is part of an apartment building or townhouse complex, you may need to contribute to a condominium fund set up to manage common areas and services. This could include paying for a gardener, cleaner, pest control and other services.
  • Interest on repayments of investment property loans: Like any other home loan, an interest rate is applied on top of your investment loan repayments. This could be on top of other ongoing home loan fees, as well as initial setup fees and legal fees that were charged when you first took out the loan.
  • Advice and water rates: Landlords are generally responsible for paying service charges or “tariffs” for water and sewer (some tenants may have to pay for this water usage). Municipal rates – which are charged by local councils and cover community projects and services such as parks, gardens and libraries – are also paid by landlords.
  • Property tax: These annual investment property taxes vary between states and territories, but are generally determined by the value of the land you own (they generally do not apply to a property where you live).
  • Renovations: If you are considering renovating your investment property in order to resell it for a higher price, there are many costs to consider. These will vary greatly depending on the type of work you plan to do, but it might be worth considering budget-friendly work-from-home options where possible if you’re looking to cut costs.

If you feel emotionally ready to start investigating investment property after reading all of this, the next step is to make sure you’re financially ready. Make sure you pass these five mortgage readiness tests before checking out the investment loans below.

* ATTENTION: This comparison rate only applies to the example or examples given. Different amounts and durations will result in different comparison rates. Costs such as withdrawal charges or prepayment charges, and cost savings such as fee waivers, are not included in the comparison rate but may influence the cost of the loan. The comparison rate displayed corresponds to a guaranteed loan with monthly principal and interest repayments of $150,000 over 25 years.

** Initial monthly repayment figures are estimates only, based on the advertised rate, loan amount and term entered. Rates, fees and charges and therefore the total cost of the loan may vary depending on the amount of your loan, the term of the loan and your credit history. Actual repayments will depend on your personal circumstances and changes in interest rates.

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