Investors are always on the lookout for their next property purchase - but there are five situations when you need to say 'no'.
Blogger: Cate Bakos, director, Cate Bakos Property
Buyers frequently contact us to 'discuss a concept' or 'formulate a strategy', but often what they have done already is set their heart on a property prior to seeking advice or having a strategy, and in so many cases, the property is a terrible idea. There are five reasons not to buy property and these five reasons can serve buyers well when they want to make a clever purchase decision.
Reason one - Retro-fitting a personal and emotional purchase decision into an investment purchase.
From holiday houses to properties which university-attending children may live in, from a lost-25 year old's dream being recreated, through to a house which one day might be a downsizer's new home, targeting an investment property with emotion is a bad idea.
Every sharp investor will agree that there are four key attributes to a great investment property:
1. Genuine and sustained growth drivers
2. Rental yield which matches the investor's required cash-flows
3. Tight vacancy rates
4. A quality target tenant pool
Getting four out of four is gold. Managing three out of four is do-able. Once an investor only achieves two out of four, the strategy starts to feel gloomy. And only achieving one is a recipe for disaster, while zero usually means that imminent losses are looming.
Quite often where we'd love to live, or holiday, or keep as our retiree-pad does not score four out of four. Take holiday homes for example. They generally score a zero or a one at best.
And targeting a unit for a pending university student-child can be a disastrous move. After all, if you cast your mind back to when you were 18 and living with your house-share mates off-campus, it's fair to say you wouldn't necessarily target that demographic of tenant for your own property. And it's very hard to take your own children to the tribunal when they mistreat the property or stop paying their rent.
Maintaining a pragmatic, numbers-driven approach is vital for any successful investment purchase.
Reason two - Chasing negative gearing tax benefits and/or depreciation
I never understand why clients come to us with the sole focus of saving tax. To claim a tax deduction means that you are losing money - whether it be a shortfall in rental income (when baselined against your mortgage and other outgoings), or be it a depreciating asset which is ageing and attracting depreciation write-downs.
Negative gearing and depreciation benefits are only worthwhile if the asset itself is growing in capital value at a greater rate than the rate of losses which the owner is sustaining. To have it any other way is delusional at best. To target a location or asset type which is not outperforming the market, yet is sustaining losses, is a sad tale indeed.
Reason three - Helping out a friend/family
Whether it be in the form of providing a roof over a friend's head when they are in need, or buying a family friend's property to help them avoid the sale process, making a purchase decision with a good-samaritan attitude can have dire consequences - and often for the friendship, not just the financial investment.
I recall a dear client during my mortgage broker days who purchased a property in a housing commission area based on a tight budget. Her plan was to house a friend and their young children for a subsidised rent. But when her friend met a new boyfriend and decided it was more economically viable to move in with him, my client was left with a tough property to rent, and one which was possibly bought above market value because of her friend-in-need's excited input at the time.
Helping out a friend is one thing, but making a business decision with them is another. Buyers need to consider their out-clauses, what-if's, and worst case scenarios before doing business with friends/family. Quite often the negative effect on a friendship is far harder to sustain than the financial loss.
Reason four - Forward planning by more than five years
I'm guilty of this one myself and I learnt first-hand how we can't really make decisions about where our life could take us beyond a window of a few years.
Back when our daughter was born, we probably did what many new parents do - and that is dream about the life we'd like to create for her. We set our sights on a life in Hobart; amongst this stunning maritime city, and enjoying the crisp cold autumns, the winter snow on Mount Wellington, and most of all, a cosy little city featuring some of the most beautiful period homes I know. Our plan was to move down there at the commencement of her schooling.
So with fast planning and lots of excitement, we found our 'forever home' in Goulburn Street West Hobart after three visits; a stunning red-brick four-bedroom Federation-era beauty with breathtaking views of the city.
Little did I know that my passion for property and my life as an advocate would carve me a place in the Melbourne market, running an exciting advocacy business. And we probably hadn't factored in how we'd feel about our little girl growing up and leaving us to chase her dreams in a wider city than Hobart.
Our life is in Melbourne and Hobart would be way too small a city for me now. I tied up good capital in a property which did not outperform the market - in actual fact it under-performed and our four-boys-at-university tenants (and probably their four girlfriends) have created much wear and tear on our gorgeous old house. It was a bad business decision in hindsight.
Reason five - Buying it because it's a bargain
Properties are bargains for all kinds of reasons. The key is to work out whether the reason is situational, or physical. Situational can relate to the vendor's timing, or perhaps their negotiating position (or lack-thereof), or maybe the sudden deluge of similar properties on the market at the one time. Sometimes it's as simple as an agent mistakenly booking auction day on a grand final or long weekend when most people are distracted away from property. These situations can be fabulous for a buyer.
But often buyers gravitate to a property because it's a bargain for physical reasons. These reasons can include location (busy main road, opposite an industrial site), difficulty in financing (these types are harder to detect and require research; non-mainstream zoning or title type are the two main offenders when it comes to banks rejecting these types of assets), or it could be that the property is in a terrible state. The latter is forgivable, but the first two are not.
Securing a bargain is one thing, but if the asset underperforms into the long term as a result of it's affliction, it was never a good purchase to start with.