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Property Accountants: Property Investment – What is it and why you should do it

 

The overall investment return on an investment property will be made up of both rental income and capital growth.

When choosing an investment property, investors are frequently tempted to pay attention to income as well in order to reduce the cash flow cost of holding the investment property.

I argue that this is a costly error in terms of missed opportunities.

Mistake

Investors could commit this error as a result of

(1) being unable to completely understand the effects of their choice,

(2) needing to adjust their intended property characteristics,

(3) having to cut back on their investment spending.

Value

By concentrating on money, you must spend more on creating value.

A property’s value is made up of two parts: the land and any improvements, such as the house. In general, land values increase, whereas buildings lose value over time as a result of wear and tear. This argument is illustrated in the table below. If you want to achieve a 7% annual rate of capital growth overall, the more money spent on the building value, the larger the rate of land value increase you will need to attain an overall growth rate of 7-8% p.a., which is a reasonable expectation for an investment grade property. To sum up, investors should concentrate on the value of the land, whereas tenants should concentrate on the quality of the housing.

Opportunity cost of concentrating on income 

Expecting an investment property to return more than 10% annually is unrealistic over a lengthy period of time, all together. 

That is, the capital growth rate plus gross rental yield cannot be greater than 10% annually. 

Property types with higher rental yields typically see slower growth. 

Given that income is driven by building value rather than capital growth, this makes sense. 

Therefore, by focusing on various property kinds, an investor can influence the composition of their return (i.e., how much income and growth they may obtain). 

Spend money on the property after you’ve bought it If your goal is to increase the amount of money you make from your investment property, I advise you to get the best possible asset for your money. Later, if you like, you can invest money enhancing the home to get a larger rental yield. The benefit of using this strategy is that you will be able to deduct the cost of capital upgrades from your taxes, which will help you pay less in taxes and increase your cash flow.

Budget

If you are concerned about the cash flow cost of investing in a land-heavy investment property, you can either reduce your budget or partially fund cash flow from equity. You could first tighten your spending limits. For instance, rather than aiming for a house, you might want to think about purchasing an investment-grade villa apartment. The key to successful real estate investing is to buy the best asset you can afford. Additionally, a high-quality property must include a sizable portion of land value. Second, if your financial situation permits, you can think about covering some of the cash flow holding costs from equity or savings rather than compromising on the features of the investment property.

My goal isn’t to persuade you to borrow more than you can afford, but rather to make you aware of how expensive it may be (from the standpoint of wealth) to prioritise income when choosing the finest investment property to purchase. It is true that many investors are (misguidedly) focused on income, and many buyer’s agents are trained to maximise revenue. As a result, I see that many buyer’s agents are trained to think that increasing rent is a crucial quality when choosing an investment property. Property Agent Consult I hope my research above shows that doing so has a significant loss of potential. Instead, I would advise buyers’ brokers to inform their customers about the costs associated with placing an excessive emphasis on income.

Then, they should revise their criteria for investment properties so that they accommodate their client’s cash flow budget while also ensuring that they choose a home with the features required to yield the maximum investment return. It is hoped that this blog will show how crucial it is to comprehend investment basics. Growth comes first, income comes second. These foundations are simple to explain and are based on fundamental logic and mathematics. But regrettably, many investors, buyers’ agents, and financial advisors lack the knowledge of this asset class—that is, residential real estate—to provide sound advice.

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