I was recently asked to speak at an investors evening for a local mortgage brokerage company and the topic I was given was the different types of property people can invest in. It got me thinking about all the investment implications of different types of property. 

The obvious consideration is the types of tenants that different properties cater too, but as my speciality is in the sale of investment property, I presented on how you exit the property in years to come. Most investors when buying focus on either the yield or the quality of the property or the type of tenant residing in their property. Few think about how they will sell the property to realise a profit once they have finished with the property. 

This means thinking about the market your property sits in and what types of buyers will purchase the property from you. Different buyers act in different ways during the different phases of the property cycle, and different properties are valued and priced by the market in different ways. Confused yet? Let me unpack this.

Suburban Homes

One of the most common types of investment property is your humble home located out in the suburbs. Investors often like this type of property as it’s relatable. Almost everyone grew up in a home like this and we understand how it works. It is generally a freehold title, four walls, a ceiling, a yard and the type of tenants that live in it are generally a nice normal family. It feels safe to many investors.

However, this isn’t an investment property. It’s a home that you have rented out to someone else. Its value is not in its rental income, but instead its value is linked to the property market of other homes in the surrounding area.

Let’s say you own the property for ten years and decide it’s time to sell. If an investor were to purchase it looking for a specific capitalisation rate, or yield, the property might be valued at say $600,000. However, the market for homes in the area are selling for $700,000. A prudent agent would advise you to remove the tenants, tidy the house for sale and present to the market as a home for a purchaser to live in, as it is worth more that way.

However, let’s assume that rents are particularly high at the time of sale, and this values the property at $800,000 against current cap rates. It might be a difficult sell when the investor purchaser could buy the identical property next door for $700,000 and rent it out for the same as yours. This means that your property, despite its rental income, is more closely linked to the surrounding market than its internal income.

Now you have to consider when you can sell. Property values vary during different phases of the cycle, and at times there are flat periods of growth in property values, so you might not realise much profit over a certain period of time. You may have to wait for the next surge in property values before you can sell to make a profit. The value of your property is linked to the motion of the property cycle.

Investment Property

An investment property’s value is weighted heavily to its rental income. These come in different forms, but can be classified as properties that a regular family would not live in. This would include student flats, duplexes, blocks of flats, older large houses split into several dwellings and boarding houses. These types of property are often more centrally located to the town centre, or in specialist areas like near a tertiary campus.

The main weight of their value can be derived by two factors; the rental income and the capitalisation rate (yield or return) at the time of sale. Other factors such as the quality of the physical property and deferred maintenance required will have a lesser impact on the value.

Therefore, an investment property’s capital performance is linked more to its ability to increase rental income over time and less on the value of other surrounding properties. The cap rates for markets don’t often move drastically, so the ability to increase the value mainly relies on the rental income.

That said, we have recently been through a period where historically low interest rates did pull down the cap rates or yields, meaning the corresponding property values jumped. The interest rates climbing again have stabilised the cap rates back to around the longer-term norm in many locations.

So despite rare blips in the cap rates, generally an investment property can enjoy steady increases in value with each increase in rent. For example, in the Dunedin student market, rent rises of $10 per room per year are common now. A five-bedroom property with a cap rate of around 7% will gain in value by approximately $37,000. That will happen year after year, so long as the rental increase occurs, and assuming a stable cap rate and you maintain the property.

A good investment property should pay for itself over time and should have a predictable value largely relating to its rental income when you want to sell. This then makes it important to understand your tenant market demand and what drives those tenants to find housing.

Apartments and Units

These are a property type many investors like but can be more closely linked to the property cycle values than the yield value. Buyers tend to seek these properties out as they are a low maintenance option, with generally a low hassle tenant.

There are many stories of tenants in suburban homes that cause damage and headaches. I’ve suffered this myself. However, tenants that opt for these smaller apartment-like dwellings generally tend to be gentle on the property. Often a Body Corporate is dealing with the maintenance and upkeep of the grounds and buildings, so these become very easy, ‘sleep-well-at-night’ investments.

Of course, many owner-occupiers also choose to live in these properties, and often we find that the value is linked to the general owner-occupier market cycle. The yield returns are usually less than your standard investment property, so capital gains in time are the aim of investors to these properties.

Property and Market Cycles

So it pays to consider the cycle you are in at the time of purchasing and what you think it will do in the medium to long term. We have recently seen a period in investment property where low volumes of sales were caused by multiple legislation and financial changes. Thankfully, the recovery is now underway evidenced by more investors enquiring every week with us. This is largely in part due to the reversal of legislation changes and the promise of lending restrictions easing.

The bottom portion of the market, where first home buyers hunt out suburban properties, has been very competitive of late. Investors with these smaller suburban properties have found that selling their properties vacant to first home buyers had been much better than selling to other investors.

The cycles will always shift and move, and when purchasing a property, you should place some consideration on how you will exit the property, not just operate for your duration as a landlord.

The statements made within this article are in the opinion of the individual writer only and do not constitute legal or specialist financial advice. Please seek independent legal and financial advice when dealing with all property transactions. 

Matt Morton is a specialist residential investment broker (since 2011).