Top ten things to look for in an investment property

Managing risk with renovation
Managing risk in a challenging market
April 15, 2016
Affordability
Affordability – not a nationwide problem
June 7, 2016

Top ten things to look for in an investment property

What to look for in an investment property

Potential for long-term capital growth.

The most important consideration when investing in residential real estate (given the current lower than average rental returns) is capital growth – that is, how much the value of the property will build over time. A rapidly growing asset will allow to you to build equity and buy more properties, even buy that ‘dream home’ more quickly.

Generally speaking, the longer an asset is held, the more profitable it will be.  Property investing is after all a long-term game with a minimum 10 year holding period given the high entry/exit costs such as stamp duty, agents’ commissions, marketing fees, capital gains taxes, etc.

When purchasing, you should buy below or at the median value for the property type within the suburb. NEVER pay above market value. Paying too much will limit your capital growth. If you are looking to build a portfolio for the long term, avoid hot markets where there is little opportunity for short to medium term capital growth. Ideally, focus on buying high quality properties in suburbs with a proven track record for strong capital growth and preferably at the lower point of the cycle. Look for areas which haven’t performed for the past 5-7 years but have had consistent rental growth of more than 20% and where future capital growth is underpinned by strong fundamentals.  The properties you buy should have the potential to double in value every 10-11 years moving forward.

 

Focus on areas where homebuyers dominate
Avoid markets that are oversupplied with dwellings targeted at investors. These investments are notoriously difficult to rent out– particularly to the right sort of tenant – as they are not in sought-after locations, neither are they the appropriate stock. These properties also tend to have lower capital growth. Top of the list in this regard are inner-city high rise apartments in Melbourne which typically attracts transient, student and short-term single and young couple tenants. Other no-go zones are areas of over-supply such as Greenfield development projects and areas zoned for high density living, with a full pipeline of planning approvals near CBDs. Focus instead on areas where home buyers dominate as purchases in these areas have a much stronger potential to be occupied (tenanted) 52 weeks of each year. Always stick to major populated centres.

 

Buy property with a strong land value component.
The land value needs to represent 70% of the total value of the property where free standing homes are concerned. Where units are concerned, stick to small blocks on larger land areas – preferably with no more than 12 units.  Generally speaking there should be a “clear property title”, which means no restrictive easements or major encumbrances.

 

Location. Location, location.
Location will not only ensure stable cash flow in terms of rental occupancy but will have the best opportunity for capital growth.  Ideally these purchases should be located in highly desirable blue chip areas or locations undergoing gentrification, usually within close proximity of our capital cities. Assets should be close to employment hubs or growth corridors, transport, good quality schools (a major driver), universities, hospitals, village-type shops or major shopping centres and recreation facilities. Ideally look for quiet, attractive streets with architecturally consistent streetscapes and limited traffic flow. Remember, properties located within walking distance to these facilities will attract premium prices. Properties close to the CBD are in shorter supply than outer-ring locations, so they will always be in demand. Also, people who rent in inner-city areas are more likely to wear periodical rent increases because they are there for the lifestyle. Location is also important when it comes to banks’ lending criteria. There are several postcodes on banks’ black lists thanks to their geography and areas of over-supply.

 

Quality residential stock.
You want a property that is not only desirable to quality tenants but will attract the best possible price when you are looking to sell. Ideally the property should be a free standing home (2 to 4 bedroom), single and double storey terrace home or an older style apartment in smaller boutique blocks (ideally of no more than 12 dwellings). The property should be structurally sound, present well or require only very minor cosmetic refurbishments.  With regards units/apartments, ideally there should be more owner-occupiers than tenants. When looking at purchasing into a strata complex always consider owners’ corporation fees, current provisions in the sinking fund (the sinking fund is an account that is established by the owner’s corporation by setting aside revenue over a period of time to fund future capital expense) the complex’s maintenance plan and likely costs to be incurred in the medium term.  Also check the overall operation – the make-up of the complex and the number of dwellings which are owner occupied and tenanted – and ‘harmony’ within the complex. The body corporate minutes will give you a quick insight into reports of disturbances, conflict, and so on. Finally, consider who you would like as your ideal tenant and whether the property would be desirable to that tenant.

 

Scarce supply
For the best opportunity for capital growth, your property should ideally carry the ‘scarcity label’ – that is, areas with a finite land supply and/or dwellings unlikely to ever be replicated i.e. period and older style homes. This type of property includes character dwellings built between the mid-1800s-1940s. They are typically Victorian, Edwardian, Queenslander, Federation Californian Bungalow, Spanish Mission and Art Deco in style. Examples of areas undergoing rapid gentrification with a preponderance of older style character dwellings include Melbourne’s inner west and inner north and the inner south-west in Sydney. Ideally, the greater the consistency of style in a street or suburb, the greater the likelihood of the property performing long-term.

 

Avoid locations that could impact on appeal.
Avoid buying a property next to establishments that could dramatically affect its cash-flow, growth performance or emotional appeal (unless there is a compelling reason). These include main roads, service stations, establishments for commercial/industrial use, commission housing, and/or medium to high-rise unit developments that might impact view and light. Always conduct checks with local and state authorities to see if there are proposed or approved developments immediately adjoining or surrounding the property. To maximise your earning potential, avoid properties located on busy main roads and homes that are too close to unattractive amenities such as factories, airports and train lines.

 

Opportunity to add value
Some properties, while not immediately appealing because of unappealing décor or a slightly dysfunctional floor-plan may have the potential to be reconfigured or refurbished; providing considerable potential. You might not have the know-how or money to renovate now, but if the property is in good enough condition to rent at the time of purchase (or could quickly and cheaply be brought up to scratch), it’s still worth a look. Perhaps you could rent it out for a few years and renovate down the track. Perhaps you could pull down the house in a few years, subdivide, and build a couple of units. Don’t immediately write off a property that might have potential to add value. There are opportunities to create capital growth by renovating but be careful not to over capitalise. When adding value you also need to understand your demographic – which is who you are trying to impress with the renovation.

 

Locations with major infrastructure spend
Ideally buy in areas or cities where there are major infrastructure projects, either under construction or in the planning stage. These drive population growth thanks to an increase in jobs growth which, in turn translate into enhanced demand for residential rental dwellings.

 

Owner-occupier appeal
Although you should give thought to who might rent your property when conducting your property search, you should also consider if it will suit the owner-occupier market in the area. This will ultimately determine its long-term value because, when it comes time to sell, you will not be limiting your market to investors only.