Choosing the right property could come down to these key aspects.
Blogger: Cate Bakos, director, Cate Bakos Property
Investors often ask me: “Where should I buy?”, “What would you buy if you had $500,000?”, or even “What are the next hotspots?”
Without knowing their specific situation, cash flow requirements or attitude towards risk, it’s an impossible question to answer.
There is a set of four ‘essential elements’ that can make a difference though, and attaining four out of four can mean a winning strategy for any investor. It’s simple, but it’s not easy.
I often say to investors: “Getting four out of four spells a successful investment experience. Three out of four generally means that the journey will still be successful, but challenges will be faced. Two out of four makes for a difficult investing adventure with plenty of upset – and any less than this usually spells disaster.”
The first essential element is that a genuine growth driver needs to be present. Growth drivers must be sustained and ideally consistent; not short term, not sporadic and not based on an employer or project with a use-by date. If a genuine and sustained growth driver is present, the investor can be confident that the reasons for the area’s popularity will remain and will strengthen. Proximity to lifestyle centres (e.g. high streets with a ‘heartbeat’, rail station, cafes, shops, schools) are usually giveaways. Genuine and sustained growth drivers spell an area which continues to attract a demographic or household that has an increasing income or a stronger income than the current snapshot demographic. Sometimes these locations are existing ‘blue chip’, tightly held and highly contested areas, while other times these locations are up-and-coming suburbs that are rapidly changing. Either way, they boast incomes flooding into them, which are constantly challenging the existing median household incomes on record.
The second essential element is the tough one; rental income matches the investor’s rental yield requirement. In short, this means that when rental income is offset by the outgoings (made up of mortgage repayments, rates, insurances, maintenance and property manager expenses), the differential is easily covered by the investor’s budget. If the net outgoings exceed the investor’s surplus income, then trouble will spell. Reasons why investors sell their investments are often based on the ongoing affordability. This sad mistake claims many an investment strategy, because often investors miscalculate the ongoing cost of ownership, or underestimate the stress a property can create when the negative cash flow threatens lifestyle-related expenses.
The third element relates to vacancy rates. To pursue a specific asset type in a given area without understanding the corresponding vacancy rates is foolish. While current vacancy rates are tough to uncover, a simple way to obtain a snapshot of vacancy rate for a given type of property is to approach a reliable property manager in that particular area and request two measures; i) total number of (x type of asset) in the area, and ii) the current number of vacant properties in that genre. Most cities feature a seasonal variance, and our warmer cities tend to track counter to our cooler cities. But whatever the season, a five per cent or greater vacancy rate should sound warning bells for any investor, and ideally a three per cent or less set of rates should be the target vacancy rate. As we tell many investors: “It’s all well and good to find a high capital growth area with nicely published rental yields, but if you have an empty property, every week will hurt you in cash flow.”
The final element is the quality of tenant. A great tenant is one who respects the property, pays on time, creates the least wear and tear on the property, asks for (only) fair items, and one who stays for their entire term (or longer). There are plenty of strong capital growth adventures I've heard of where the investor’s experience was fraught with stress, upset, damage, tribunal appearances, hearings, arrears, fights and frustration. A quality tenant can make the difference between an easy ride and a difficult one. It’s all well and good to find a hotspot with exciting returns, but if the trade-off means that the landlord will have to field and endless array of troublesome calls from their property manager, they need to question whether their speculative decision was worth it.
When an investor can bank on solid, sustained capital growth, rental income which meets their needs, a constantly tenanted property and a happy, respectful tenant; their journey is as positive as it could be. Rather than hunting down the next hotspot, investors should target a property that comes as close as possible to ticking off these four essential elements.
Four out of four makes for a happy investment journey.