Property investors often want to know where to buy next, but sometimes in their search for the next hotspot they're missing some important variables.
People ask me all the time "Cate, where is the best suburb to invest?" It's a crazy idea. It's like going to the pharmacist and simply saying "I don't feel so good. What is the best medication to take?"
Without knowing ANYTHING about a person's household cash-flow, future plans or commitments, how can I possibly make a recommendation or a diagnosis?
Instead of asking "Where is the best suburb to invest?", they should ask me "Where is the best suburb for ME to invest?" The way to work out WHERE the ideal investment area is, and which property type is best suited is SIMPLE, but it's not EASY.
Firstly I find out a bit of information about what magnitude of SURPLUS income the household has (and is prepared to apportion to property investing). That means, when the income rolls in and the expenses, bills, discretionary spending and provisioned money is subtracted, what is left? This surplus amount may constitute ALL of the excess income which the aspiring investor is prepared to apportion to the purchase, or it may constitute just a PORTION for the purchase (perhaps assigning the remainder of the surplus for other investment, whether it be another property or a different asset class investment). But what is VITAL is that the investor understands their surplus LIMIT. To go into investing without understanding the limit is essentially committing financially to something you aren't sure whether you can afford or not.
The next question I ask relates to borrowing capacity. Some folks are cash flow-rich and asset-poor, while others are the opposite. New job starts, changes of career, poor credit conduct and unemployment can adversely affect an individual's borrowing capacity, so not only is it important for me to know that the aspiring investor has pre-approval, I also need to understand the bounds of their pre-approval, including their maximum limit.
With these two important pieces of information at hand, the only other question I have relates to the aspiring investor's plans, preferences and attitude towards risk. They may have a negative association with an area or a type of property. They could hate weatherboards. What I need to navigate through are their preconceived ideas and their genuine criteria objections. For example, a prospective investor might be time-poor or unprepared to deal with significant maintenance or improvements. This will shape the type of asset I could target for them. They may have negative ideas which could be based on stigma, outdated information, a sense of emotion or guidance from a source who is not experienced in property investing. I actually spend a lot of time 'reprogramming' aspiring investors to think 'business-like' and not emotional. Those who look at investment properties as though they are going to live in them can reduce the best options significantly. Unless the aspiring investor's profile and demographic is representative of the 'target tenant' for the given area and asset type, it's not a good yardstick to adopt. But while I spend a lot of time educating and 'reprogramming', I always say to the prospective investor "I want you to be proud of your asset". After all, it's their money and they will hold the property long after my assignment is complete. The worst legacy I could leave someone is to select an investment which they dislike or are ashamed of.
My aspiring investor's borrowing capacity might be $450,000 (as an example). If their apportioned cash-flow monthly limit is $700 per month then the asset might be a renovated villa unit in an up and coming inner ring suburb. But if their monthly limit is $1200, their asset might be in a blue-ribbon style suburb where rents are typically lower and capital growth prospects are strong and demonstrating historical consistency. However, if their cash-flow limit is closer to neutral or slight, they may be better suited to buying two houses in a regional area where growth is more moderated, yet gross yield is closer to 6%. What this demonstrates is that various areas in any given state will offer differing rental yields and differing growth. Understanding total 'out of pocket' expenses per month relies on calculating the following:
rental income MINUS -
- mortgage repayments,
- insurance (including owner's corporation fees if applicable)
- maintenance costs
- property management fees
Tax benefits need to be well understood if they are added back and the investor must be prepared for annual refunds unless they explore other options with their accountant.
Once the investor is aware of the the 'out of pocket' costs which any given property type in a given area represents, they are closer to understanding which property or area is the right one for them based on their assigned surplus income contribution.
Finally and most importantly, the area and property type must pass two essential tests. They must exhibit strong (and consistent) growth drivers and tight vacancy rates. These two essential elements are a good basis for my next article!
Reproduced in full with permission: Smart Property Investment May 2014.
Attention: This article is intended to provide general information only. Every attempt has been made to ensure the accuracy of this information at the date of publication. The opinions expressed in this article do not reflect those of DHA, its staff or agents. Property prices are subject to fluctuation. Prospective investors should seek independent advice. DHA will not be liable for any loss, damage, cost or expenses incurred or arising by reason of any person relying on information in this article.