Is the expectation of high reward over a short period of time too much of a gamble in the property market?
Blogger: Cate Bakos, director, Cate Bakos Property
From renovation to subdivision, reconfiguration to development, there are multitudes of methods to add value to property. People specialise in it, developers often make significant profits and investors often gravitate to clever ways of making money. So why do these ideas need a degree of caution? And what are the risks?
Let’s talk frankly about making money quickly in property. It’s not as easy as it sounds. I often advise clients to find another asset class if fast profits are what they are looking for. This isn't because fast profits are impossible; but because so many people think they can replicate others’ successes with limited effort, they don’t consider the negative impact if their plan doesn't come to fruition. Australian capital city properties have certainly been kind to investors over the long term. Our growth trajectory has been positive and our supply and demand balance has been attractive for those who own property. As a passive-investor (one who doesn’t actively improve or manage the property themselves, but outsources to professionals), property gains can be exceptionally attractive for a well-located asset when time is allowed to do its thing. This is the type of investment philosophy I have followed myself for the majority of my portfolio, and is the approach I follow for the majority of my clients.
The difficulty in trying to manufacture equity is four-fold, and one thing for certain is that profits can’t be guaranteed, nor are they achievable for many folks.
Improving a property physically requires expense. Whether a tradesperson is assigned to the task and paid, or whether the investor is able to do the work themselves, someone’s time needs to be remunerated. Investors who don’t put a value on their own time are not being realistic about the total project cost. Every hour that an investor spends working on a property is an hour less that they are working in their day job. I use my own job as an example when I get asked about whether I’d develop or renovate. I love being a buyer's advocate, and I feel that my time as an advocate is far more productive than if I turned to renovation or project management.
And for those who try to fit their property project around their paid job are spending less time with their loved ones; a price that is definitely hard to measure.
To compound this, many people assume that their renovation will add more value than the cost of the materials and labour. Often this is the case, but I've seen plenty of cases where investors have overcapitalised (spent more on the renovation than the value that they've created).
Scoping out the cost, the benefit and having contingency for overruns is essential.
Builders and tradespeople are particularly good at manufacturing a profit. They have access to materials at trade prices, they have good tradesperson connections and, most significantly, they can operate on an attractive scale of economy. For an inexperienced investor with limited renovation experience, profit can often be a mirage.
For those who are fortunate enough to create value through their renovation, holding versus selling needs to be a serious consideration. When the decision to sell is made, (this is a ‘renovate and flip’ strategy), the investor then needs to calculate the impact of these three elements on their gains:
For some, the gains are whittled away by the above; particularly if a strong sales result is not achieved.
Other common wealth creation thoughts that are floated by me include subdivision ideas. From selling parcels with plans and permits, through to development; many inexperienced investors feel that this is a quick path to attractive profits. In an ideal scenario where other experienced developers aren’t aware of the property for sale (where competition is low), and when local council says ‘yes’ to the proposed plans promptly, where service connection is not problematic, and where neighbours don’t object, this can be a fantastic opportunity. But the chances of road bumps or, worse still, road blocks are high. The most upsetting thing a new investor could face would be finding out that they can’t do what they planned to do with their newly purchased investment property. Having a great town planner and a high level of confidence about what’s permissible is imperative.
The third common ideal I get quizzed about is ‘picking the next hotspot’. Data is one thing, but genuine and sustained growth drivers are the key. An area can boom for many reasons; but the investor needs to be confident that it won’t then flop, or languish after its micro boom. Many who have pounced onto the mining region opportunities over the last four years have had sad tales to share. Time in the market (as opposed to timing the market) is a luxury that many investors can benefit from – provided they have left themselves enough time.
Where there is high reward over a short period of time, there is usually risk.
Investors need to answer these five questions honestly before they commence their fast-profit strategy roll-out;