All Topics / Help Needed! / Working out what to pay for investment property based on rental return?

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  • Profile photo of MuddleMuddle
    Member
    @muddle
    Join Date: 2014
    Post Count: 4

    Hello!

    We are currently debating over the possible purchase of a rental property leading us to fall at the first hurdle…..

    See, as IP novices we have realised we don't know the answer to this simple question: how do we work out how much we should be purchasing the property for based on its gross rental yield?

    The property is on a single title, but is comprised of two independent units.

    Their combined gross rental per month is $2080 ($1120 for unit 1 and $960 for unit 2).

    Their rental history is proven and 12 month leases are currently in place.

    Both units are 1970s built and had comprehensive renovations about 18 months ago and have come up well in the building inspection.

    Bottom line: how do we do the sums to work out a fair purchase price?

    M x 

    Profile photo of Mick CMick C
    Participant
    @shape
    Join Date: 2010
    Post Count: 1,099

    "fair purchase price" doesn't always go by rental return/yield, only works for certain areas and property type.

    There's a lot more to "fair purchase price" than JUST the rental return..

    What are you actually looking for ?? a number/purchase price where you can break even with your rent??

    Mick C | Shape Home Loans
    http://www.shapehomeloans.com.au/
    Email Me | Phone Me

    Same Banks. Better Rates. Served With a Passion.

    Profile photo of MuddleMuddle
    Member
    @muddle
    Join Date: 2014
    Post Count: 4
    Shape wrote:
    "fair purchase price" doesn't always go by rental return/yield, only works for certain areas and property type.

    There's a lot more to "fair purchase price" than JUST the rental return..

    What are you actually looking for ?? a number/purchase price where you can break even with your rent??

    Thanks Michael:

    Perhaps ignore my use of 'fair'.

    What I suppose I was looking for was some type of equation to work backwards from the rental gross to give me some indication of the likely purchase price. But I think you are telling me such a thing is impossible without taking into account other factors.

    M x

    Profile photo of Mick CMick C
    Participant
    @shape
    Join Date: 2010
    Post Count: 1,099

    The equation does exist, but really need to look at other factors as well….as standard it may sound – it does depend on the area your investing.

    Ie for example: A older style 2 bedroom unit in Westmead ( Sydney) rents for $400pw — it would sell for average $450,000  — the gross return is 5.2%

    ( years rent/ purchase price )

    Now lets say we took a drive 20 min away Westmead  and we used this same equation ( but in reversed) say for a unit in Macquarie Park  ( Sydney) – 

    A 2 bedroom unit in Macquarie Park  ( around 20km away  or 20 min drive away from Westmead) ) rents for $430pw  — the purchase price to receive 5.2% return would make the property be "worth" $430,000…. impossible ~ older 2 bedroom units in Macquarie Park sells for on average $530,000.

    Now lets do the reverse and go 23km out the other direction ( also 20 min drive from Westmead) and go west to St Marys.

    A older style 2 bedroom unit in St Marys ( Sydney) rents for $280 pw — the purchase price to receive 5.2% return would make the property be "worth" $280,000…. however you can pick up older style units in St Marys for around $250,000.

    ^^ Above are just some  examples….


    So really some areas  and some property type you an use some sort of equation…So yes numbers and "rental return is very important" but it doesn't always determine the property value. 

    Hope that wasn't to confusing lol..

    Mick C | Shape Home Loans
    http://www.shapehomeloans.com.au/
    Email Me | Phone Me

    Same Banks. Better Rates. Served With a Passion.

    Profile photo of BennyBenny
    Moderator
    @benny
    Join Date: 2002
    Post Count: 1,376

    Hi Muddle,

       … and a big welcome to you too.   Good to see a new member "jumping right in the deep end and posting"  smiley  

      I believe that in the Commercial Investment arena that is exactly how one determines value – all based on yield.   But hey, that also might fall over in a similar way to Shape's comment re "location" – I don't know.  The comment re Commercial was "something I read" and I noted at the time that it was quite different to Residential Investment in that way.

       With residential, location is a huge factor and each house has its own "features" that make it different from the one next door.  As such, I guess your next move should be to endeavour to gauge (from the RE agent – or more than one agent) the expected "market value" of this place.  Once you know that, you can calculate the yield (or use Steve's way, and set the yield you want, which would then dictate the price you would pay).   Of course, in that instance, you may need to find an area that will provide such a yield, or find a bargain that allows it – but in the latter case, watch out for "Why would no-one else buy it?"   All part of due diligence.

      Do you have a particular yield in mind?  Oh, and "As much as possible" is a FAIL mark – sorry !!  cheeky   It all depends on what you are seeking – can you renovate?  Are you looking to subdivide?    Develop?   Are there other ways you can add value to a place to increase its yield, even if it didn't quite meet your initial benchmark?  Change its use – e,g, go from family rental to student accommodation, shared housing, etc.

      Meanwhile, keep on reading (and searching) as there might already be threads on here that can provide you with answers.

    Benny

    PS   Oh, and just a hint here:-

    Quote:
    The property is on a single title, but is comprised of two independent units.

     

       That would tell me that the units should sell for LESS than equivalent strata titled units – maybe even a lot less.   Keep in mind, that the seller has a much more limited market with such a sale.   They can sell to investors (primarily) or perhaps a family that wants to provide an extra unit for grandma/pa, aunt/uncle, etc – or a "Home and Income" for someone wanting a bit more than just a home.   So the numbers of potential buyers drops markedly – this should work in YOUR favour.  Just don't let an RE agent mislead you by comparing their value with other (strata titled) units..

    Profile photo of MuddleMuddle
    Member
    @muddle
    Join Date: 2014
    Post Count: 4
    Shape wrote:
    The equation does exist, but really need to look at other factors as well….as standard it may sound – it does depend on the area your investing.

    Ie for example: A older style 2 bedroom unit in Westmead ( Sydney) rents for $400pw — it would sell for average $450,000  — the gross return is 5.2%

    ( years rent/ purchase price )

    Now lets say we took a drive 20 min away Westmead  and we used this same equation ( but in reversed) say for a unit in Macquarie Park  ( Sydney) – 

    A 2 bedroom unit in Macquarie Park  ( around 20km away  or 20 min drive away from Westmead) ) rents for $430pw  — the purchase price to receive 5.2% return would make the property be "worth" $430,000…. impossible ~ older 2 bedroom units in Macquarie Park sells for on average $530,000.

    Now lets do the reverse and go 23km out the other direction ( also 20 min drive from Westmead) and go west to St Marys.

    A older style 2 bedroom unit in St Marys ( Sydney) rents for $280 pw — the purchase price to receive 5.2% return would make the property be "worth" $280,000…. however you can pick up older style units in St Marys for around $250,000.

    ^^ Above are just some  examples….


    So really some areas  and some property type you an use some sort of equation…So yes numbers and "rental return is very important" but it doesn't always determine the property value. 

    Hope that wasn't to confusing lol..

    Lol! No that all makes sense! I think!

    If I told you preliminary discussions are that the property will be on the market for 300k – 320k would it seem like we have stumbled on a bargain or something to be wary of? The suburb is a bit more 'up market' than St Marys. It is a small suburb, largely residential with few units or flats. It is close to a less desirable suburb with bit of a reputation. The property itself over looks Crown land which is largely a wetlands reserve. Close to CBD, has nearby schools & public transport access.

    Hmmmm……

    M x

    Profile photo of MuddleMuddle
    Member
    @muddle
    Join Date: 2014
    Post Count: 4
    Benny wrote:
    Hi Muddle,

       … and a big welcome to you too.   Good to see a new member "jumping right in the deep end and posting"  smiley  

      I believe that in the Commercial Investment arena that is exactly how one determines value – all based on yield.   But hey, that also might fall over in a similar way to Shape's comment re "location" – I don't know.  The comment re Commercial was "something I read" and I noted at the time that it was quite different to Residential Investment in that way.

       With residential, location is a huge factor and each house has its own "features" that make it different from the one next door.  As such, I guess your next move should be to endeavour to gauge (from the RE agent – or more than one agent) the expected "market value" of this place.  Once you know that, you can calculate the yield (or use Steve's way, and set the yield you want, which would then dictate the price you would pay).   Of course, in that instance, you may need to find an area that will provide such a yield, or find a bargain that allows it – but in the latter case, watch out for "Why would no-one else buy it?"   All part of due diligence.

      Do you have a particular yield in mind?  Oh, and "As much as possible" is a FAIL mark – sorry !!  cheeky   It all depends on what you are seeking – can you renovate?  Are you looking to subdivide?    Develop?   Are there other ways you can add value to a place to increase its yield, even if it didn't quite meet your initial benchmark?  Change its use – e,g, go from family rental to student accommodation, shared housing, etc.

      Meanwhile, keep on reading (and searching) as there might already be threads on here that can provide you with answers.

    Benny

    PS   Oh, and just a hint here:-

    Quote:
    The property is on a single title, but is comprised of two independent units.

     

       That would tell me that the units should sell for LESS than equivalent strata titled units – maybe even a lot less.   Keep in mind, that the seller has a much more limited market with such a sale.   They can sell to investors (primarily) or perhaps a family that wants to provide an extra unit for grandma/pa, aunt/uncle, etc – or a "Home and Income" for someone wanting a bit more than just a home.   So the numbers of potential buyers drops markedly – this should work in YOUR favour.  Just don't let an RE agent mislead you by comparing their value with other (strata titled) units..

    Hi Benny!

    thanks not only for your detailed response, but also for the friendly welcome. I love that people are responding to my ill defined rookie queries!

    I follow what you mean about commercial vs residential values.

    Still, without going into all the ins & outs here, I am a bit puzzled. There is a discussion of a possible price tag of 300 – 320k. Which would give it a yield of (where's my calculator?) let's say, over 8%. This leaves us to think it has been under valued or we are missing something obvious!

    It is a small fairly non descript suburb that we are very familiar with. It is largely residential with few units or flats. It is close to a less desirable suburb with bit of a reputation. The property itself over looks Crown land which is largely a wetlands reserve. Close to CBD, has nearby schools & public transport access.

    Gauging the market value is a tough one: neighbouring properties (all single dwellings) sell around the 300k mark & are rented for around $280 pw. So, we wonder if the single title issue could reduce its value THAT much? That is a difference of over 12k annually in rental returns.

    Okay, so it is an unusual property: it started life as a single dwelling that was extended and then divided, hence the separate units (individual meters etc) on the one title. It is recognised by the local council and lands dept as having two dwellings on site, but I do take your point about this versus 2 strata title units. Thing is, the purchase of 2 x strata units locally (in that neighbouring down market suburb with a reputation) would be almost twice the purchase for half the rental return. Does its status as an unusual property matter that much if it appeals to renters and remains well maintained and attractive to renters?

    in regards to possible improvements: not sure any would be useful… Converting it into one very large single dwelling would seem counter-productive. There is room to further develop the block, but doubt that would get council approval at this stage, plus it would diminish the appeal of the existing units. One unit could be adapted to include an extra bedroom/study that might improve the rental return a bit, but with recent renos it looks only the usual maintenance and improvements to a property of its age should be necessary for the foreseeable future at least.

    now I am discussing far much more than I intended to…. And boring peeps in the process…..but it looks like the short answer is there is no easy formula to estimate market value and we are back we we started…. Without a clue about this IP business!!! Lol!

    M x

    Profile photo of waydo77waydo77
    Participant
    @waydo77
    Join Date: 2011
    Post Count: 155

    Do some research on demographics in the area and see if the property (each one seperately) would suit the most dominant demographic, have a look at similar rentals in the area, talk to other agents, tell them you have this property and you would like to rent it, see what the demand is like, if all that is good you may have found a bargain :)

    Profile photo of Matt_ArnoldMatt_Arnold
    Participant
    @matt_arnold
    Join Date: 2006
    Post Count: 142

    Hi Muddle

    This software will very quickly (with some reasonable accuracy) tell you wether a property will be CF + or CF – 

    http://www.somersoft.com.au/piafpu.htm

    You can also play with the figures – Eg. What is the cash flow difference between a purchase price of $300K vs a cash flow price of $320K

    Having said that, as mentioned above, there really isn't a direct correlation between rental returns and purchase price for residential property the way there is in commercial…

    Matt

    Profile photo of shuelswittshuelswitt
    Participant
    @shuelswitt
    Join Date: 2014
    Post Count: 1

    Hi all,

    just a few comments / questions from another novice.

    The way I'd be looking at this is:

    1. Do you want this property to be CF+ or looking for capital gains?

    2. Do you need to take a loan out to cover a purchase price (how much will obviously impact the CF)?

    If the above are true, a CF neutral formula looks like:

    Fixed Costs + Loan Repayment = Gross Rental Yield

    or

    Loan Repayment = Gross Rental Yield – Fixed Costs

    Where Fixed Costs is maintenance, rental management, Council rates etc.

    From this you can work out what the loan repayment can be, and from that an acceptable price. If the loan / price works out less, you’re into CF+.

    This is just if you’re looking at Cashflow rather than capital growth and yield.  The yield figures above really just outline the potential payback of investment.  You’re not taking any costs into account, which will obviously really impact your true “yield”.

    Profile photo of BennyBenny
    Moderator
    @benny
    Join Date: 2002
    Post Count: 1,376

    Hi Muddle,

      Well, these extra words tell me that you may have indeed stumbled across a "bargain"…..  

    Quote:
    There is a discussion of a possible price tag of 300 – 320k. Which would give it a yield of (where's my calculator?) let's say, over 8%. This leaves us to think it has been under valued or we are missing something obvious!

    ……………….

    Gauging the market value is a tough one: neighbouring properties (all single dwellings) sell around the 300k mark & are rented for around $280 pw. So, we wonder if the single title issue could reduce its value THAT much? That is a difference of over 12k annually in rental returns.

      From your earlier words, it sounded to me like you might be going to pay a price for each unit.  If indeed the price is for BOTH units, then this sounds like a VERY interesting proposition.   It also shows that these "units" are deemed to be around half the price of ordinary strata units – so no rip-off there.   And to get double the income for the cost of just one ordinary unit or house, sounds worthy of some quick due diligence and lock it up if it all passes muster.  

      Re due diligence, one obvious requirement is to endeavour to determine the "reason for selling".   It could be a deceased estate, where the family has no interest and just want it gone.  OR, it could be that something else is known about this place that makes it a problem for the seller – they just want to quit it – quickly.  

     Your mission is to endeavour to understand what may be hidden.   e.g.  Is it full of termites?    Is there a block of flats about to go up next door, which will cut out your sunlight?   Is there a new road proposed heading right through the property?   Local gang issues?   etc.  etc.  One neat trick is to go "see" the place at different times of day/night.   Just park and observe.   Gauge the "neighbourhood" – listen for raised voices, watch for any unusual "pedestrian or vehicular activity", smells (any abbatoirs nearby?), etc.   Go before school, after school, early evening, later evening – if you can.  A "wait and watch" could turn up some answers – or not.

      On the face of it (with that more complete explanation from you) it strikes me as quite a deal if any "hidden surprises" aren't too much of a problem for you.  Good hunting – now it's time to get your skates on…..   cheeky

    Benny

    Profile photo of mattstamattsta
    Participant
    @mattsta
    Join Date: 2011
    Post Count: 604

    If you're worried about the hidden surprises, you could do due diligence and inspect it yourself, as well as get pest inspection and building inspection done.

    For gang issues, you could visit the property and get a feel of the surrrounding neghbourhood. Also talk to some locals in the area to figure out the good and bad areas.

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