How to Identify a BAD Investment Property

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Buying a home that you would want to live in forever is often an emotional decision – there are times you could be in love with the cosy porch or the modern kitchen and even imagine yourself raising your own family in that abode. But it’s entirely different when you’re buying an investment property. It is important that you decide rationally rather than emotionally.

But what makes a good investment-grade property? What are the factors that you should be looking for when trying to find one?

What Should you Consider in Choosing an Investment Property?

A good property can either be a success or failure as an investment, that’s why it is best to have the right foundations if you want to grow your portfolio. If you’re building a property portfolio without a strong base foundation –you might not be able to get to the next level, meaning securing a second property; or you just might get stuck with the first property for a long time before you get to jump to property two.

Location is Priority

In many instances, people usually talk about the property first and then the location. Forgetting that ‘LOCATION, location, location’ is key. In fact, most agents say that a large chunk of their hard work is driven by location. So, investors should really focus on investment-grade locations if they want to be successful.

Some first-time property investors who are in a rush to buy a standalone property at all costs likely go for something 50 – 70 km out.  Not realizing that if they had a acquired a townhouse nearer one of the big developed areas, it could yield a better result.

Get this: an average-looking house in an excellent location is better than a great-looking house in a regular location.

So, you may ask:  What makes a location great? Many experts will tell us that a location near the CBD or maybe the beach is crucial – as is proximity to lifestyle amenities like restaurants, parks, food & deli stores, coffee shops, reputable schools and universities and accessible public transport.

A golden principle of real estate is location and this matter because location is permanent, unlike a home.

The best scenario is choosing an A-grade location with an A-grade property, However, if you are to decide with only one factor – go for the right location.  One can change the property, but NOT the location.

Strategic buyers often look at high-demand areas with limited new stocks coming up in the market.

For investors – another tip is to check what the vacancy rate is for the suburb they’re seeking.  As it is the topmost goal of any investor to ensure that they can have their property rented out.

There are so many investors who purchase in a particular area but have not considered whether the property can be easily rented or not, forgetting that this can impact their cash flow and lifestyle routines.

   Academically, the lower the vacancy rate is, the better for investors as it is indicative of a positive outlook for capital growth.

On the contrary, a high vacancy rate can be taken as a cautionary warning of oversupply (such as a cluster of new high-rise flats or apartments being constructed in the area) — as this implies that these investors will wrestle to get their property rented out since they will all be targeting the same group of tenants.

The industry-known fact of a market imbalance standard is about a 3% vacancy rate; thus, investors should try to target those suburbs with a vacancy rate lower than that.

Capital Growth Potential  

Aside from buying a property in a suitable location, property investors should also aim for properties that have good potential for capital growth, to be combined with a good location.

Property investors should aim for locations with a good history of high capital growth that will continue to yield good performance and even outdo the averages for reasons like the area’s demographics, including areas undergoing or have already experienced gentrification.

What is capital growth? Capital growth is how the property is appreciating in value over time. It is key for investors building their wealth, so it is an essential factor in property investing

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Majority of the investors are quite focused on rental yield, getting depreciation and tax savings. But what they should be looking at is capital growth — the kind of suburbs and properties that will provide valuable capital growth. Because without this, then you’re just putting in too much risks with small reward.

Investors may also want to check for properties where they can produce or manufacture capital growth by way of redevelopments or renovations.

Scarcity Aspect

There are a host of explanations why property experts argue that apartments which are off-the-plan are most likely bad investments. One of the reasons is that the high-rise and medium-density accommodations usually have just a bit to no scarcity level.

The reality is that even if high-rise developments are intended for the investor market, this doesn’t confirm that they are investment-grade.

But they are what the property developers and marketers sell in its immensity to the inexperienced and trusting investors – and normally off the plan, but they are not investment-grade due to less owner-occupier buy in and they are not scarce. Further, there’s no opportunity to add value to them and they are usually sold at a premium.

Investors should target those properties with a unique, special or even scarce appeal. An example is an ancient-style apartment constructed between the years 1920-1970 with an architectural design that is rare, scarce and has a perpetual appeal.  These types of properties are usually situated on areas where land is in-demand and rare.

Period homes or those with character as well as art deco are oftentimes regarded as good investments since demand for these kinds of properties is usually greater than the supply.  

Increased High Land to Asset Ratio

Increased land to asset ratio does not really refer to a huge block of land but it means that the land element comprises a rather substantial portion of the asset value.

Most people will desire to own a fourth or fifth of a block of land beneath an apartment structure in a significant inner suburb versus a big block of land within regional Australia. 

It is important to know the property’s land to asset ratio because land value normally increases and this impacts price growth while the building is considered a depreciating asset, meaning it goes down in value. As a result, it therefore pays to have the land value as a significant share of the property.

From an investment point of view – one should try to pick an asset where land makes up most of the value of the property, ideally about 70%, with 50% as the minimum.

One can have a high land-to-asset ratio due to the following: older dwelling, huge land size or a high value of land per square metre.

Among the three scenarios – it is crucial to focus on the last one since it is usually present in the most sought-after locations.

In highly desired and in-demand locations which are generally near the CBDs, it is notable that the suburbs are more established and have several character-style, older homes.

These properties generally are better in terms of land-to-asset ratio versus buildings most recently constructed which still need to realize their depreciation costs. 

Appeal to Owner-Occupiers

As per Australian Bureau of Statistics (ABS), two-thirds of Australians live on homes they own, and the rest are renting.

With this, the owner-occupier appeal must be what the investors will need to find as these buyers are the biggest sectors of the market.

Investors should aim for properties which will attract a variety of owner-occupiers.

It helps if the investor-clients are thinking like owner-occupiers as this appeal to owner-occupiers is clearly a good foundation for capital growth.

It is because owner-occupiers tend to buy with their hearts and not their heads. This kind of buying behaviour drives market prices to go up.

Perhaps, a big mistake that investors usually commit is that they’re buying investment stock without thinking of the bigger market out there. No secondary market is present for that kind of stock lest it has an appeal to the owner-occupiers.

So, in the end – the owners-occupiers and investors combined are the ones who drive the prices up. But of course, you wish there were more than one group of buyers who are interested in your property down the road when it’s time for you to sell it.

This will be crucial as the volume of investors in the market is more likely to be reduced in the future.

Aside from being in a good location, what the owner-occupiers normally search for in a property are the following: lots of natural light, street appeal, openness, good ventilation, remarkable floor plan, a good, big storage space and a good linkage from indoors to outdoors.

How A, B and C-grade Properties Matter?

The term ‘A-grade property’ is often talked about, but what does it really mean?

There is scarcity in the A-grade assets as it something that most people want.

A-grade properties have attributes that entice buyers to buy them over others.  An illustration would be that in a family-oriented location – you would want a property that will have maximum appeal to families in the area. Thus, a five-bedroom home will be more attractive than a three-bedroom one.

People would always pine for all those characteristics that an A-grade property would have more of. If there were several properties in the market – no doubt you would want your property to stand out. You wouldn’t budge in and have that irregular block or perhaps, buy on a main thoroughfare or go for one with a sharp block. You would want to buy something that has everything in it.

This is what A-grade means – it has more features which most people prefer.

Grade-B properties are typically in the correct suburb, but not certainly where buyers wish them to be. Some of these properties may be too far away from the basic amenities, do not have parking lots or have uncomfortable floor plans.

A particular B-grade property could be on a good road but well, the property might not have much emotional appeal with its actual design or architecture, but the thing is – it is suitably located.

C-grade properties can be located on a main street or a sharp or abrupt block having much lesser appeal.

C-grade is using the cookie-cutter approach so there’s really nothing special about it.

But the property grade presents a weighty subject since it will influence how the investment will do.

Know what?  The A-grade property will increase at a level more than the median price. If all goes down and further – it will likely not go less than the median.  So, it will often do better than the median.

One saying that goes around with property is this: “A rising tide lifts all boats.”  This does not make sense. For any particular property on any suburb – there are some that perform well than the rest.  Hence, they are not similar or equal in going up or down at the same levels.

Another one to quote here is “safe as houses.”  This is baseless since there are more people losing money in their properties which happen more frequently than people want to discuss them.

Comparing Capital Growth and Rental Yield

One does not need to allow to hold on to the property as the concern on A-grade asset is that they’re definitely hard to purchase with a competitive price.  You will have to shell out more when buying such properties definitely.  More often than not, A-grade properties provide lesser yields.  This is kind of contradictory to what you are expecting.

People always want to be on the safe side. They tend to get out a loan for less amount and they prefer to receive higher rent as this will make them feel a bit more comfortable and secure.  They can pay off the mortgage, however, the issue lies on the investor just buying to accumulate rent. In reality – you are not really buying an asset which you expect to multiply in value.

As you can see – the higher your yield, the higher your risk as well plus the capital growth potential is lessened.  In such case, both yield and growth seem to be mutually exclusive of each other.

But rental yield is much of a less indicator for a good investment property though they benefit cash flow.

Even if capital growth is what you’re pursuing – it’s the rental yield that you want eventually. This is because you want to take advantage of the passive income you gain from renting out these properties.

It is best to pursue capital growth as you begin your investment accumulation path. But towards the end, you may want to give up the debt obligation so then you may give up the rents. But this is not always the case since a few do not have much equity so they depend on the early rent returns they can get hold of.

Most of the time, the people who invest for the purpose of having cash flow never actually creates the financial freedom they want.

It is said that one can’t save his way to wealth. This implies that capital growth should be the primary goal of every property investor and not cash flow at all, not in the short-term at any rate unless an ample huge asset base has been made. 

Sadly, this is how Australian property investment operates – it’s certainly not a cash cow.   By all means, cash flow is vital to allow you to play in the game, but of course, what keeps you out of rat race is the capital growth.

Do Not Buy Property for Depreciation and Tax Reasons

Our suggestion is this: Never buy an investment property (especially if off the plan) just for tax and depreciation reasons.

In simple math – you have to spend one dollar to retrieve the maximum 47 cents or whichever is the present tax rate. This is certainly not sound.

In case you’re not using capital growth as the main reason for buying a property – then why should you lose 53 cents for every dollar that you’d be spending?

If you check off the plan sales in both Brisbane and Melbourne – you may find that some have lost cash on the second resale within the past 10 years.  And some were even on a losing stance.  This means it’s costly to pay to have some good depreciation advantages.

A big number of first-time investors are drawn in buying an investment property, off the plan apartments for one, due to depreciation reasons.

Most of these investors were lured by some cunning salespeople who are saying that they must buy properties for their tax and depreciation benefits.

But this should just be a bonus. You should do property investing primarily for the growth potential before you even worry about any tax results.  

You wouldn’t buy off the plan for depreciation either – put together that investment first and then ensure you maximize the depreciation you can have after the purchase.

Final Thoughts

Buying an investment property entails a number of considerations on your part. It is worth to note though that your decision must do good for your risk profile, personal investment goals and your current condition.

Is it affordable for you to buy an investment property and hold on to it?   It is definitely unreasonable to purchase an investment property if the costs of holding on to it will have unfavourable effects on your current lifestyle and monthly cash flow.

As a general rule, you must thoroughly think about your personal financial status plus it’s best to discuss this with a qualified and competent financial adviser before you plunge into any major investment decision.

Inevitably, there are several factors to think about when making that investment property purchase, and so far, – we’ve only just began.

Want to Know What are the Best Locations to Buy Investment Properties?

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