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When it comes to property investments, there are many myths and misunderstandings surrounding property returns. When looking at their property returns, many people fail to consider the comprehensive picture of their total return or return on investment (ROI). Very often, they only focus on a single aspect, which can be dangerous for property investors wanting long-term success.

Watch our YouTube video, Does it Still Make Sense to Invest in Property in South Africa?.

Understanding your property investments’ total returns has many benefits, including accurate evaluations of the financial viability of your investments and assessing risk and potential rewards. But to truly understand the ROI of your property investments, it is crucial to consider the following two fundamental factors:

1. Your Property Price Growth (Capital Appreciation Rate), and
2. The Net Rental Yield (Capitalisation Rate for Commercial Property).

The Property Price Growth or Capital Appreciation Rate

The Property Price Growth, also known as Capital Appreciation Rate, is the percentage with which the market value of a property grows annually. It is a crucial concept for you as a property investor to understand, and you should be able to use it to assess the potential profitability of investments. By understanding and analysing Property Price Growth, investors can make informed decisions and strategise for long-term financial success.

The Net Rental Yield or Capitalisation Rate for Commercial Property

Property Price Growth, however, is not the only return you get on your property investments. In addition to Property Price Growth, you also receive monthly rental income, whether you are renting the property yourself from one of your entities or leasing it to a third party.

The Net Rental Yield, or Capitalisation Rate for Commercial Property, calculates the return you receive on your property investments after all the property expenses have been paid. The formula to calculate it is as follows:

Net Rental Yield = (Rental Income – Levies – Rates & Taxes – Rental Commission – Maintenance) x 12 / Purchase Price or Market Value

P.S. It is important to remember that your property has expenses associated with it, such as rental agency commission, levies, rates and taxes, and maintenance. One must also keep in mind that you might not always have a tenant, so there may be some vacancy costs to consider as well.

When making your projections, it is always best to be conservative and base your calculations on 10 months’ rent, budgeting one month for potential vacancy and one month for maintenance.

A low-risk investment is one that keeps its value and slowly but surely increases its value and rental income, which should remain consistent and consistently grow.

It is also good to keep in mind that the average year-on-year Property Price Growth (Capital Appreciation Rate) for any consecutive 20 years in the last 50 years is significantly higher than the current growth rate. And since input costs, such as land prices, and material and labour costs, have increased significantly (more than what property prices have increased), it is very possible for property prices to start growing at a higher rate in the future.

Also, this is not considering that your rental income grows every year (rental escalations) or that you can buy a property at a discount (below market value). Both of these factors can significantly increase the returns discussed above!

When interest rates are decent or low enough, and Property Price Growth or Net Rental Yields are strong, leverage or gearing becomes an attractive strategy to increase your returns significantly.

Leverage means using Other People’s Money (OPM) or the bank’s money. So, instead of using your funds to invest in property, you can borrow money from the bank to build a large asset base without using any of your own funds, or at least very little of your funds.

Read our article, How to Leverage with Property.

Leverage also amplifies the existing result, which means that it can turn a small positive return into a big positive return. But be warned; it can also turn a small negative return into a big negative return. So, proceed with caution!

It is thus important to ensure that the combination of your Property Price Growth and Net Rental Yield is more than you pay in interest. This is, of course, over the long term, as there are times when your interest rates are high while your returns are comparatively low.

By understanding the intricacies (and myths) of property returns, you can maximise your returns and reap the benefits of property investment over time. Just remember to consider the growth potential, rental income, and leveraging opportunities when appropriate, and you’ll unlock the secrets of ROI on your property investments in no time at all!

Read our article, The Risks and Rewards of Property Investment.

Read the entire article in the June Edition of Real Estate Investor Magazine.