There are several reasons real estate is the most popular tangible investment on the market: revenue streams from rentals; long-term capital growth; consistent historic growth performance and high-levels of demand within a low-risk environment.
Here, we are going to take a look specifically at capital growth and rental income and how to locate the most profitable investment opportunities in an increasingly over-crowded market.
When a property appreciates in value, it is known as capital growth. Capital growth has been very strong in major international real estate markets in the last two years with properties in London appreciating by a massive £260 a day in 2014.
Although real estate is less reactive than for example, foreign exchange or equity markets, negative or positive influences tend to be more protracted, as is natural in a slower-paced climate. This can make it easier to know what to look for when sourcing your next investment in terms of finding out what positive or negative dynamics have existed and are likely to exist in the area and how that has and is likely to impact property values.
Fortunately or unfortunately, depending on your perspective, we are not born with the ability to see into the future. The only way we can gain a good understanding of what is likely to happen is by taking a look at what has happened already.
The key things to look out for when assessing capital growth potential of an investment property are:
- Infrastructure improvements, driven by companies moving into the area; new transport links; local government regeneration budgets; enterprise initiatives and low unemployment.
- A location within close proximity of a more established, attractive area so that where you invest is likely to be 'discovered' by tenants looking for cheaper rentals in more up-and-coming locations.
- Select the type of property that has the strongest and fastest-growing level of tenant demand relative to the supply of properties of that type.
- Know who your tenant is likely to be: young single professionals; couples; families; students: business travellers; private tenants or those on local housing allowances. Different types of tenants have differing requirements and varying rent expectations; shorter-term tenancies can result in more void periods – these are all considerations an investor needs to factor into decision-making.
- What level of furnishings, fixtures and fittings (if any) the tenant will expect a landlord to provide. For example, many tenants will expect an internet connection but it has to be clear from the outset which party bears the costs of providing it.
- Determine the level of rent you can expect to achieve and how quickly you can expect to receive it. Is demand strong enough to prevent void periods or have you selected wisely, where rental demand is consistent and growing?
- Consider what changes are happening locally that will affect future tenant demand and local property prices. Are there any major companies setting up locally? Is there a thriving university within a short distance? Determine where your tenant market is and its prospects relative to your investment.
- Take a look at what is in the construction pipeline in the area. Is the type of property you have chosen to invest in likely to fall into over-supply because of new developments?
With a property investment your biggest cost is likely to be your mortgage. If you are investing in a low-cost income-generating unit, for example student accommodation or mixed-use residential property, your investment is more likely to be in cash which is more straight-forward when calculating rental yield.
On the premise that your purchase was leveraged, you deduct whatever repayments you make from rental income earned and that gives you the net expected rental yield for your property.
If you divide this into the value of the property including all the costs associated with buying it, you have the 'true' or 'net rental yield'.
Example: If net rental income is £10,000 and the property cost £200,000, the net rental yield is simply £10,000 divided by £200,000 which equals 0.05 or 5%.
It is important to be realistic in your expectations of yield with an income-generating asset and it does not necessarily follow that if there is a shortfall because your rental income is less than the mortgage repayments that you have invested unwisely.
If you have bought well, in an area with a strong growth outlook your rental income is more than likely to rise over time. Importantly, as your rental income is improving your property is appreciating in capital value, underpinning the security of your investment.
There are likely to be additional costs incurred by letting your property out for which you will have to budget carefully. Costs to consider are:
- Insurance premiums
- Replacement of fixtures and fittings
- Ground rent and service charges
- Void periods
Don't get emotionally involved with your investment property
This is hard because property is an emotive thing. Even if you don't choose to live in the property, you are aware that you are providing someone with a home and that's a big deal.
However, this attitude will not help you make the best buying decisions. You have to remain totally detached from your investment purchase and consider only the numbers and how they stack up.
That's not to say that you can disregard your target tenant's needs and requirements because you won't be living there yourself. Being a best-practice landlord is integral to the success of your investment. Knowing and understanding your tenant will ensure your property is well-loved and lived-in, ultimately contributing to its capital growth.
No matter where in the world you are considering investment, the fundamentals remain the same. If you consider the above points when reviewing investment properties and carefully incorporate them into your selection criteria, you can't really fail.
- Thursday 05 February 2015