Let’s start with a case study. Two friends have decided to buy an investment property, both are at similar stages of their lives, can afford a similar purchase price and contributions to any shortfall that may occur per month on the investment. They even have a very similar contribution to put towards their investment. Both research thoroughly and as they are different people, they have different ideas on where best to buy and what type of property. Also their monthly incomes and cash flow situation are comparable.
So both people are doing their research and investor 1 attends an opening on an inner city development. The wow factor is there, Stamp Duty savings, beautiful views, great location, easy to rent and brand new to boot! Investor 1 goes for it, feels that as it has some time to finish it will appreciate and once finished will be a star on the rental market. Investor 1 would live there if they were a renter, close to everything and great for a night out or dinner at a restaurant.
Investor 2 takes a little more time, investigates the market and considers all options, including some less desirable areas. Investor 2 also has an imagination but can visualise an average house on a nice sized block in a potential up and coming area. Investor 2 isn’t so worried that the property looks like it needs a good clean, a paint job and a big day in the backyard by a local Jim’s Mowing franchisee or their equivalent. Investor 2 goes for it and buys the property, 60 day settlement, full Stamp Duty, knowing their next few weekends post settlement might be spent working around the property and visiting Bunnings!
Both these investors assume they are building wealth and an asset for the future and they are. Both will be receiving a passive income from their investment and some possible tax benefits as well.
Who has selected the better property to increase their wealth?
Investor 1 is happy, they have renters in, are getting a great return, are receiving great tax benefits and also depreciation due to the property being modern. Investor 1’s cash flow is not overly affected due to the great rental returns, although the Owner’s Corp fees are high.
Investor 2 is also happy, after some work on the property it was rented out, not a great return but the area seems like it is on the improve, some small subdivisions and townhouse projects are occurring. Investor 2 is contributing a little more monthly than Investor 1 but is able to manage.
After 18 months, both investors go to their mortgage broker and request up to date valuations of their investments as they have both been satisfied with their investment purchases, have had their accountants complete their tax returns and received some tax benefit. They would like to know what their current investment is worth and can they possibly buy another in the future and instead of saving, they’d like to utilise their equity, ie the potential capital growth in their investments.
Investor 1 gets a shock as their valuation has come in $20k less than the original purchase price. Investor 2 gets a nice surprise, their valuation has come in $60k higher than they originally purchased for. Who has selected the better property? Like all things, this relies heavily on personal circumstances. We have discussed this previously in the article capital growth versus rental return in April and it all depends on what you want from your investment, your stage of life and your cash flow position. However in this instance, Investor 2 selected the better property because they now have options, options to release further equity for another purchase, to renovate their existing investment etc. Investor 1 really just has to hold on and enjoy the good return on their property and not sell.
Property Selection is Crucial!
So property selection is vitally important to your investment strategy and to create wealth. Keep in mind land generally is the appreciating asset and the dwelling is the depreciating component. What other factors should go into property selection? Think about demographics, planning regulations, levels of current and future stock, public transport, access to shops and amenities, uniqueness etc. Research is not ploughing through the Internet looking at properties, anyone can do that, look deeper into the property and particularly the area and its surrounds, there will be far more you will discover than simply checking a floor plan on a real estate asset.
There is also a difference between a cheap property and an undervalued one, look for the best value, not the cheapest purchase price. Only a small percentage of the available properties on the market could be classified as investment grade stock, these are the properties you need to find or get an expert to find for you.
Please keep in mind, not all property appreciates at the same rate and double every 7-10 years, in certain markets some property values have barely moved in a decade. Think about how to add value to your investment to increase both the potential return and the growth, you might be able to manufacture equity quickly and cheaply with the right property and the right vision. Spending 5-10% of the property purchase price on quick and efficient improvements can make a massive difference to your investment.
Please get in touch with our team of fully qualified and experienced buyer advocates if you are considering an investment purchase – we’ll help to steer you in the right direction.