We often see alerts in the media about property hotspots – cheap suburbs about to boom – or the ‘bargain of the week’. Purchasing a cheap property in a booming area can be an excellent move, as it provides an affordable entry point into the property market and a chance to build some equity. But is it an effective strategy for longer term investors?
I started building my property investing portfolio always wanting a bargain – and a bargain basement price at that – but investment strategies change. I’m now happy to pay a reasonable price for a property in the knowledge that it will be a consistent grower.
Look at the overall picture of the decision you’re about to make and analyse its benefits. In the early days, when you’re trying to get into your first property and you don’t have much of a deposit or cash flow you may need to concentrate on short term goals. But once you’ve built some equity, you could afford to forego some immediate profit now for greater profit over the longer term.
There are two areas to look at here – the property itself, and the suburb it’s in.
Property with the lot vs a bargain
A cheap property might be attractive because of its price and its ability to give you instant equity, but what if it was harder to attract tenants or perhaps wasn’t likely to grow? Would you still buy it? After all, don’t they say ‘you make a profit when you buy real estate, not when you sell’? There’s no easy answer and one size doesn’t fit all. As with any investment, you need to analyse the pros and cons of your decision.
Many people do look at certain properties because they are a cheap entry point into the market or because the vendor will sell at a bargain price. These are all short term benefits and should be weighed up against the long term disadvantages. In a healthy market, most properties should sell for around what they’re worth. But some properties don’t – they stay on the market, get stale and then if the owners are desperate they get sold at a very cheap price.
I believe it’s properties such as these that you may want to avoid. Perhaps it has no parking while every other property in the block or street does; maybe the bedrooms are too small to fit double beds into; maybe the apartment is too small so the banks won’t lend on it; maybe it’s next to a nuclear power station! You need to recognise these disadvantages, weigh them up to see if they can be fixed at a reasonable cost, or if it’s something that will limit the attractiveness for tenants or its future sale value, no matter what you do. If it’s the latter, maybe that short term gain may not be worth the long term problem.
Conversely, a property that has everything ticked off – such as location, direction, parking, size, condition, proximity to transport – is likely to attract a lot of attention and demand, even in a market that isn’t running hot. And with all that demand there is a chance that the sale price might actually exceed the property’s value. Is it worth paying more for a property than it is actually worth?
My number one tip in property is always to get an independent valuation before you buy as that will almost guarantee you will never overspend. But sometimes rules are meant to be broken. If a property with all the necessary attributes is likely to grow quicker than one with a few things missing, wouldn’t you always want to get the one with all the ticks?
If you’re an investor for the long term, it may be the better decision – even if it does cost you a slight premium.
The property with all the ticks may very well grow at 10 per cent – and it may not be as susceptible to the market forces that affects the less desirable one.
Let’s say you’re faced with two purchase decisions:
- a 100 sq m two-bedroom unit valued at $330,000, but selling for $300,000 because it’s on a main road;
- a 70 sq m two-bedroom unit valued at $270,000 in a cul-de-sac, and which might very well sell for $300,000 because of the desirable street.
Would you pay 10 per cent more for a property with all the ticks, or 10 per cent less for a property with a large disadvantage? The table below shows how much the 70 sq m unit is worth after 10 years and 10 per cent growth, compared with the 100 sq m unit, which might achieve only 6 per cent growth.
As you can see, after 10 years, the property with all the ticks (10 per cent growth) is worth $134,000 more than the discounted property, even though the latter is technically valued at $60,000 more at the start. If you bought the 100 sq m property and took into account this initial loss of $60,000, you would still have $74,000 more in equity after 10 years. And you start to build more equity, that equity can be used to purchase even more better-performing properties.
It’s important to be realistic, however, about the disadvantages that can and can’t be removed within a property.
Things that can’t be fixed
- No parking
- Main roads, major noise
- Opposite industrial construction – electricity pylons
- Poor positioning
- Aircraft noise
- Poor natural lighting (in a unit)
- Exterior (large unit blocks)
Things that can be fixed
- Interior decoration
- Exterior decoration
- Configuration of rooms
- Minor noise (through double glazing)
- Unattractive garden
- Poor natural lighting (in a house)
I often buy properties that are undervalued, do them up and hold them for the long term. But there are still lots of properties that I see what I wouldn’t buy no matter how cheap, because I think they will be hard to tenant and they won’t grow as much as the slightly better properties in the same street or suburb. Even if I bought them and sold them on very quickly, virtually all of my profits would get eaten up in buying and selling costs and capital gains tax.
Beware property hotspots
Property hotspot predictions are always in the news, but do you really want to buy into them? Not always. A suburb is dubbed a hotspot because it is just about to undergo massive capital growth, and that has to be good for any of its property owners. It gives you instant equity and also gives you a chance to build a deposit for your next purchase. But are there any disadvantages?
- The boom doesn’t happen. If something is predicted as a hotspot, there has to be a risk that it won’t happen. What if you bought into an area that was predicted to grow but didn’t?
- The boom peaks but then troughs. What if the hotspot does grow for a few years but then nothing happens for decades? Ask yourself if it would be worth all that capital gain if you then had to sell a few years later when prices dropped. After the cost of getting in and then out and having to pay all the taxes, will there be any profit left?
- Are you in the know? You might have timed your entry into the hotspot well, but do you know when to get out – or will you be the last one to know?
Mining towns are a good example of these problems. They often boom quickly – and people will pay any price or rent to get in – but when all the mining finishes and the jobs go these properties are worth little.
As your investing strategy develops you might then be able to afford to buy into premium suburbs. The advantage is that these properties are likely to always have a good rent and consistent capital growth because there is a demand throughout the year, no matter what is going in the economy. They are often located 5 to 15 kilometres from a major city and are close to work and leisure facilities, such as beaches, lakes and parks. The disadvantage is that you may need to sit and wait – while growth is consistent, it may not skyrocket overnight.
Again, there’s no right or wrong with these things. You need to assess how much expert knowledge you have in the particular area you’re buying into and whether the reward is worth the added risk.
Chris Gray is the Property Expert on Channel 9’s MyHome TV, and author of Go For Your Life: How to Turn You Weekdays into Weekends Through Property Investing. Chris builds property portfolios for investors – finding, negotiating and renovating on their behalf. For more information and for Chapters 1-2 of his book for FREE, visit www.goforyourlife.com.au