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Calculating an Average Annual Capital Growth Rate

Download our example of an annual average capital growth rate calculation [ Microsoft Excel .xls file 27KB ]

The annual capital growth variable has a significant influence on the calculation of investment return, probably more significant than any other residential property calculation variable. It is therefore imperative that careful consideration should be given to the level of growth that is included in a property investment return forecast and that various scenarios should be measured against one another in order to reach a prudent property investment decision. We would however like to emphasise the importance of considering all variables that have a significant effect on the forecasted investment return that can be achieved from a residential property investment - our aim is simply to highlight the importance of the annual capital growth variable and to provide guidance with the calculation.

The residential property market, like any other investment market, can be subject to volatility at times and it is therefore not recommended to simply use the current average annual capital growth rate to forecast investment return. The current average annual growth rate should however play an important role in the assumptions that are used in order to calculate an average annual capital growth rate for the entire intended investment period. The current growth rate can be based on the house price inflation data that is released by some financial institutions on a monthly basis and estimates can be based on the movement in these house price indexes. There are a number of residential property indicators that are released regularly in the media, for example ABSA's house price index, Standard Bank's residential property barometer and ooba's price barometer - our preference is the ABSA house price data because of the number of years that this property index has been released and the volume of transactions that are included in the data.

Once a capital growth benchmark has been established, the property investor needs to estimate the growth levels that can be achieved over the intended investment period. This estimate can be based on the economic data that is available at the time as well as similar historic data over a comparable investment period. For example, a trend of increasing interest rates would usually lead to a decline in house prices and vice versa (there is however numerous other factors that could also influence house prices!). The following calculation methodology should be used to calculate the average annual capital growth rate over the intended investment period. The calculation is best illustrated through an example:

A residential property is acquired for R1 million and the estimated annual capital growth rates are as per the table below. The intended investment period is 5 years.

Year
Capital Growth %
Market Value
1
1%
R1,010,000
2
5%
R1,060,500
3
10%
R1,166,550
4
12%
R1,306,536
5
15%
R1,502,516

The first step in the calculation of the average annual capital growth rate is to determine the market value at the end of the intended investment period. The market value is calculated as follows:

R1,000,000 x 1.01 = R1,010,000 x 1.05 = R1,060,500 x 1.10 = R1,166,550 x 1.12 = R1,306,536 x 1.15 = R1,502, 516.

This means that after five years of variable annual capital growth, the market value of our example property is R1,502,516. The average annual capital growth rate for the entire 5 year period can now be calculated by using the RATE financial function (in Microsoft Excel) - you can download a free capital growth calculation template on the Templates page of our website.

The result of the calculation is that an average annual capital growth rate of 8.2% is achieved over the five year investment period in this example. This growth rate can now be used as the annual average capital growth rate if you want to compile a property investment return forecast based on a fixed average annual capital growth rate (if the calculation solution that you are using does not make provision for variable annual capital growth rates). This calculation methodology can also be used to calculate the average annual capital growth that is achieved from an existing residential property investment. Simply use the current market value, adjust this value by the estimated variable capital growth rates over the remaining intended investment period to arrive at a market value at the end of the intended investment period and perform the above financial calculation over the sum of the investment period that has expired and the intended further investment period.

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