I remember a pithy epithet trotted out by several of my teachers when I was younger around the spelling of the word “assume”, one frequently used to encourage us to find out our facts before making decisions or sweeping statements. I’m sure you’ll know what I’m talking about, and how we are all so regularly reminded that it is indeed one of life’s great aphorisms.

To provide a case in point, I recall working with an investor who had purchased a three-bedroom house for $400,000 with a yield of around 6.5%.

Immediately post purchase, he had spent $10,000 on a quick renovation to split the living room into two bedrooms and convert the property into a five-bedroom home, thus enabling him to garner a larger rental return. So far, so good.

However, part of his motivation to do this had been an anticipated six-figure increase in value – and on the basis of additional rent at a 6.5% cap rate he was envisaging very soon to be in a position to expand his portfolio. Alas, this is where his logic broke down.

Residential property is valued considering the highest and best use of the property. The most commonly used method in valuing single family homes and land is the sales comparison approach, which provides a valuation by comparing your property with recently sold properties that have similar characteristics. In order to provide a valid comparison, each must:
• be as similar to the subject property as possible in both size and location;
• have been sold within recent sales in an open and competitive market; and
• have been sold under typical market conditions.

The bottom line here was my client’s house had not grown in size, and houses across the street of similar stature were still selling for around $395,000. No one – least of all the bank – was going to be fooled by a $10,000 wall in the living room, which is why it’s so important to do your homework before making any significant investments.

Find Out Development Constraints

If you are looking to develop a property, whether you already own it or are seeking to invest, my first piece of advice would be to study your district plan. Information outlining the specifics of what is allowed in the property’s particular area will be freely available online and at most councils.

As an example, I live in an area of Wellington deemed “outer residential”. Among other restrictions in this zone is the site coverage rule, which stipulates houses must not extend over more than 35% of the land. This means that if I had a 160m2 house on a 460m2 section, I couldn’t add anything or subdivide without going to council to request a non-conforming application. This can be a long and costly process, usually requiring consent from neighbours or anyone who would be affected by the non-conforming use, with no guarantee of success.

Therefore before making any commitments, understand how the rules will influence your approach. Get a planner. Get a surveyor. And get a valuer!

Invest some money up front in this: it might not give you the answers you want. But, at the very least, it will allow you to enter into the process with your eyes wide open and weigh up the true cost of development against the potential increase in rent and value.

Factor In Insurance

Traditionally, insurance premiums have not been a significant factor in valuations, save for the inclusion of a statement in the valuation report that either assumes the property is insurable, or identifies it as being in a high-risk area.

However, in the wake of our major earthquakes and the growing threat of climate change, we will likely see a significant expansion of areas considered high-risk, where lenders will increasingly consider the cost of premiums against serviceability. I’d anticipate that this change in dynamics would see values drop in certain areas - so for the uninformed, this could be a trap lying in wait.

Work Out Your Tenant Profile

Understanding an area’s, or even a street’s, socio-demographic profile will enable you to gain an idea of your likely tenant and annual rental income. For this don’t be afraid to chat with local real estate agents; and consult Trade Me and the stats pages in this publication for further market rental guidance.

There are some simple rules of thumb that can help you plan. For example, well-maintained properties that are located in the city or fringes and close to public transport, supermarkets and major employers will almost always have long-term demand with low vacancies and steady turnover. Meanwhile, properties in close proximity to universities may tend to bring in higher comparative weekly returns, but these can be offset by increased vacancies and the potential for higher maintenance costs.

Another thing to bear in mind is government intervention – not just in terms of statutory requirements, but the impact of these changes on market dynamics.

‘Understanding the true value of your property is a key indicator of the return you can expect in the long run, either individually or collectively as part of a wider portfolio’

For example, a growing trend we’ve seen is that recently proposed changes designed to favour tenants have had the unintended consequence of encouraging investors to look outside of conventional rental agreements to embrace the flexibility of platforms such as Airbnb. Owning and managing rental accommodation does not have to be a linear process; the size and location of a property could dictate that its greatest value to you sits outside of the traditional norm.

The Cost Of Compliance & Non-Compliance

Investing in the fundamentals required to attain compliance as a rental property is unlikely to add significant monetary value to your investment. However, it is still a cost to consider that may impact your yield calculations. Basic requirements such as heating, insulation, ventilation, drainage and draughtstopping are not luxuries to justify a premium rent. So if you need to make mandatory upgrades, consider these additional costs and their maintenance requirements when assessing the true value of the property.

The Importance Of Valuation

What’s the property really worth to you within the context of your investment strategy? Are you looking for capital growth? High long-term yield? A quick flip?

When you buy a property, you don’t have the convenience of a term deposit or a fixed interest account that quotes you a rate of return, which is why understanding its true value is a key indicator of the return you can expect in the long run, either individually or collectively as part of a wider portfolio.

Remember the school days advice and don’t “assume”. We base our valuations and advice on more than three decades of experience and research. Take time to understand the numbers and you will be far more likely to realise the true potential of your investment ambitions.