How to calculate the value of an investment property

Couple standing in kitchen holding a clipboard, considering investment property purchase.

Property prices have skyrocketed over the last year, but recent lockdowns have caused a ripple of uncertainty in the market which could be a precursor to a brief period of that price growth plateauing. And if you’ve already had your eye on house sale listings for a while, this movement might have you thinking about investing.

However, if you’re buying a property as part of an investment strategy, you need to consider a few extra cost factors than if you were planning to live at the address.

While the upfront price you pay is important in determining the value you’ll get out of the investment over certain periods of time, there’s a lot more that goes into calculating the value of this type of investment. 

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

Market value vs investment value

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

Market value is the price you’ll get for an asset – in this case, a piece of property – in the current marketplace reflecting current market conditions. So essentially, it’s the price a property is being advertised for at any given time.

Investment value is the price an investor is willing to pay to acquire an asset based on subjective goals, criteria or opinions. So, this means if a property investor estimates a piece of land or a home will increase in value or provide other profits to a point that satisfies their goals, they may be willing to pay more than market price for it in line with their calculations.

But how do you calculate what that value is, and therefore what the return on your investment could be? Figuring out the capitalisation rate is a good way to estimate this potential, especially when it comes to rental real estate. 

What is a capitalisation rate?

A capitalisation rate or ‘cap rate’ for short is a simple calculation expressed as a percentage that estimates a property’s profitability, generally in terms of annual returns. There isn’t necessarily an ideal cap rate as every property investment involves different risks and costs that can change over time, but it can be a useful way to compare this kind of investment against others at any one point in time.

To figure out a cap rate you first need to calculate the property’s actual or potential net operating income (i.e. the money that’ll be going back in your pocket). To do this you minus expenses like maintenance costs, home insurance and taxes from the gross income, which is often generated through rental payments. This is expressed as: 

Gross Income – Expenses = Net Operating Income

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

Net Operating Income / Market Value = Capitalisation Rate 

Let’s look at an example. Say you purchase 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 accumulative operating costs come to $8,000, meaning your annual net operating income is $18,000.

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

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

As you’re considering other properties or other kinds of investments like shares or putting your money away in a savings account to earn interest, you can then compare the returns on these investments (and the risks) against this figure.

Ongoing investment property costs

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

  • Repairs and maintenance: If you’re renting out your property, you’ll have signed a lease agreeing to organise and cover various maintenance tasks or emergency repairs. These may be routine or pop-up unexpectedly, so you’ll need to budget for this or consider insurance for when disaster strikes.
  • Insurance: You might consider taking out a landlord insurance policy to cover your property for things like storms and fires as well as tenant damage. While every policy will cover different events to varying limits and exclude some circumstances, an insurance policy is generally a good back-up plan in case things go wrong and you don’t have the finances to sort out investment property damages or lost rental income.  
  • Property management: Some owners choose to manage a property themselves, but others hire real estate agents or property managers to deal with day-to-day issues. A property manager will save you time, but naturally comes with a price tag.
  • Strata fees: If your investment property is part of an apartment block or a townhouse complex, you may have to contribute to a strata fund which is set up to manage common areas and services. This could include paying for a gardener, cleaner, pest control and other services.
  • Interest on investment home loan repayments: Like any other home loan, an interest rate is charged on top of your investment loan repayments. This could be in addition to other ongoing home loan fees, plus any initial set-up costs and legal fees that were charged when you first took out the loan.
  • Council and water rates: Landlords are usually responsible for paying service charges or ‘rates’ for water and sewerage (some renters may have to pay for that water usage). Council rates – which are charged by local councils and cover community projects and services like parks, gardens and libraries – are also paid by property owners.
  • Land tax: These annual taxes on investment properties vary between the states and territories, but are generally determined by the value of the land you own (it’s usually not applied to a property where you live). 
  • Renovations: If you’re considering home renovations for your investment property so you might resell at a higher value, there are numerous costs to consider. These will vary significantly depending on the type of work you plan to do, but it could be worth considering budget-friendly home renno options when possible if you’re looking to keep costs down. 

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

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* WARNING: This comparison rate applies only to the example or examples given. Different amounts and terms will result in different comparison rates. Costs such as redraw fees or early repayment fees, 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 is for a secured loan with monthly principal and interest repayments for $150,000 over 25 years.

** Initial monthly repayment figures are estimates only, based on the advertised rate. You can change the loan amount and term in the input boxes at the top of this table. Rates, fees and charges and therefore the total cost of the loan may vary depending on your loan amount, loan term, and credit history. Actual repayments will depend on your individual circumstances and interest rate changes.

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