How to build more capital and master the market: part 1

The vast majority of property investors rely on the belief that in the long term, property prices always go up: “If I buy and never sell, I can’t go wrong! I’ll never lose money and in the end I’ll be better off! And the more I buy, the better off I will be.”

Interestingly, an analysis of Australian median house prices from the day of Federation (1 January 1901) until today illustrates that after inflation you can expect an average growth of just 3 per cent per annum from owning property for the long term – not too much more than the interest earned in a term deposit, really.

While the concept behind “buy, hold and never sell” is simple, its success relies on you maintaining an income to service the debt and to repeatedly come up with substantial deposits in order to buy more properties. When they recognise that this approach can be restrictive, many investors begin to think about different ways to invest in property for better returns, sooner.

Of course, straying from the slow road for faster and greater returns introduces risk and uncertainty as short-term property prices can fluctuate up and down. Suddenly there is a chance of loss and a threat to the retirement lifestyle – not something smarter property investors like to gamble with.

Managing risk
Are there ways to mitigate these risks? What might an investor need to do to build back confidence?

There is an answer and it all boils down to two fundamentals: knowing the numbers; and reading the market you are buying into.

Knowing the numbers
What does it take to know the deal? Knowing the deal is all about becoming familiar with the strategic approach you’ve chosen to take on, and all of the numbers within it from end to end. (Remember, if you are looking for greater returns faster, then the odds are you’ll need to sell the property at some point in order to release your funds and borrowing capacity to go again!)

As an example, taking on a cosmetic renovation strategy means knowing:
•‍ ‍The purchase price
•‍ ‍Stamp duty and other purchase costs
•‍ ‍How long you propose to take to complete the renovation so you can budget the holding costs for your vacant property from settlement (purchase) to settlement (sale)
•‍ ‍The renovation budget
•‍ ‍The costs to sell your property once renovated
•‍ ‍The price you need the market to pay in order to walk away with the profit you seek

Critically, you’d also need to be very clear on your available finances:
•‍ ‍How much cash you have to cover the deposit, purchase costs, holding costs and renovation costs
•‍ ‍How much you could borrow

Your numbers give you direction. Knowing these numbers gives you the basis to find the right area to begin the search for the ideal project that suits your budget and profit expectations. Knowing these numbers allows you to calculate the median price of the suburb that best suits your finances.

In the case of the cosmetic renovation, the median price of your ideal suburb is a little over two-thirds of the difference between your purchase price and the proposed selling price for your renovated property.

For example, if your purchase price was $300,000 and you plan to sell your renovated property for about $400,000, then the median price of the suburb you should be searching for would be approximately $365,000.

Reading the market
The second fundamental, reading the market, has been an elusive quest for answers for many researchers and experts for many decades – until now!

If a property investor could predict the future then all the risks of property investing would evaporate – instantly! Knowing the direction of property price movement means knowing which suburbs to buy into, when to buy into them, how long to hold the property and when to sell out. There’d be no downside and you’d always be in growth!

There are many statistics gathered and reported today in an attempt to help investors read the market better and invest more wisely. However, so much information has led to confusion about which statistics are important for prediction and which are not.

What are we looking for?
The key to solving this problem is to consider what effect we want to measure, then what causes that effect.

The primary indicator we want to be able to predict is median price movement. Getting this right will tell us if the suburb we are interested in buying into will support building our asset base for retirement or not.

Don't miss my next blog, where I show you how you can predict price movements in property markets across the country and how this will help improve your portfolio.

Read more:

5 reasons not to fall in love with your investment property

Capital growth versus cash flow

3 unexpected benefits of investing in property

Why some properties don't pass the valuation test

The real costs of being a landlord