Professionals such as economists, valuers, investment advisers and accountants have different rules or heuristics for valuing investments. These are useful but ultimately the only figure that matters is the one that ends up on a contract of sale. The price that a willing (informed) buyer will pay, and a willing (not too eager) seller will accept, is accepted as being the market value.
Buying a large asset, such as a property, at market value is easier than selling it. Focusing with the end in mind helps make better buying decisions. Are we buying it for:
Potential capital gain
Or a combination of income and capital gain.
Not overpaying for a property is important because of the selling costs (commission, legal fees etc.) if things go wrong. Having said that, when we look to buy our first property we shouldn’t look for ‘the deal of the century’ because we probably wouldn’t recognise it, even if it was staring us in the face. The saying ‘buyer beware’ may have been written for this situation. It can be better to buy a reasonable property at a reasonable price and when we get more experience, opportunities become more obvious.
Multiple dwellings such as a block of flats, boarding-house, student accommodation or caravan park are generally valued on the income yield or number of permitted tenants basis. As an example, if the accepted revenue yield for a type of property is 8.5% and we increase the income by $8,000 per year the value increases by $94,177 ($8,000 ÷ 8.5%). Increases in rents may be possible if the existing rents are below market rent or if we can increase the number of tenants.
Let’s assume that a type of property is valued on the number of tenants, and the accepted value is $100,00 per tenant. If we can increase the number of tenants by modifying the building through an addition or converting large rooms into smaller rooms and get three more bedrooms, then the building will increase in value by $300,000. Converting storerooms etc., into extra bedrooms will also increase the value. Of course, there will be renovation costs, but we will know these before we start.
Often a cosmetic makeover of cleaning, painting, and landscaping will bring increased rents (and therefore value) by making the property more attractive to tenants.
Renovations cannot breach planning rules or insurance policy conditions.
Understanding the key factors that influence value can prevent overpaying for an investment property and/or increase long-term wealth.