Obviously, this is one of the most important questions one needs to ask before purchasing an investment property. But how do we come to the answer?
For us, we like to look at three key factors, namely: rental yield, potential capital appreciation, and confidence in the location.
Rental Yield
Rental yield is one of the first things we look at when assessing an investment property. Put simply, it tells us how much rental income a property generates in relation to its purchase price.
A simple way to calculate the gross rental yield is:
Annual Rental Income ÷ Purchase Price × 100 = Gross Rental Yield
For example, if you purchase a property for R1,000,000 and receive R8,000 per month in rent, your annual rental income would be R96,000.
R96,000 ÷ R1,000,000 × 100 = 9.6% gross rental yield.
However, it is important not to stop at the gross rental yield. While it gives you a useful starting point, it doesn't account for the costs associated with owning the property. Levies, rates, insurance, maintenance, vacancies and management fees can all have an impact on the actual return you receive.
This is why we prefer to look at the net rental position as well. A property with a slightly lower gross yield may, for example, have significantly lower running costs and ultimately provide a better overall investment.
Potential Capital Appreciation
Rental income is only one part of the equation. The other major consideration is what we believe could happen to the property's value over time.
Capital appreciation is the increase in the value of the property from the price you paid to the price you could potentially sell it for in the future.
This is where the fundamentals of the property and its surroundings become particularly important. We look at factors such as:
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Demand for property in the area
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Historical price growth
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Development and infrastructure
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Supply of competing properties
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Access to schools, shopping centres and major transport routes
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The type of tenant or buyer attracted to the area
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Future development potential
Of course, nobody can predict exactly what a property will be worth in five or ten years. Past performance is not a guarantee of future growth. The objective is therefore not to try and predict the future, but to identify properties and locations where there are sound fundamentals supporting long-term demand.
Confidence in the Location
The third factor is perhaps the hardest to put into a spreadsheet: how confident are we in the location?
A property can look fantastic on paper, but if the surrounding area is experiencing declining demand, an oversupply of properties or other structural problems, the numbers may not tell the whole story.
When assessing a location, we want to understand why people want to live there and whether we believe that demand is likely to remain.
For us, this means looking beyond the individual property and considering the bigger picture. What is happening in the surrounding neighbourhood? Who is buying and renting there? What developments are taking place? Is infrastructure improving? Are businesses moving into the area? And perhaps most importantly, would we be comfortable owning a property there ourselves?
Putting It All Together
Ultimately, there isn't one magic number that tells you whether an investment property is a good investment.
We believe the best opportunities are those where the three factors work together:
A healthy rental yield + potential for capital appreciation + confidence in the location.
The weighting of each factor will depend on your individual investment strategy. Some investors may prioritise strong monthly cash flow, while others may be more focused on long-term capital growth.
The important thing is to understand what you are buying, understand the numbers, and have a clear reason for believing that the property will continue to be desirable to tenants and future buyers.
And that's where having a good understanding of the local property market can make all the difference.