Unfortunately many investors unconsciously allow their 'ego' to control their property decision-making process which often results in a purchase that will cause them trouble.
Blogger: Kevin Lee, founder, Smart Property Adviser
All too often people purchase a property in what they perceive as a quality, or affluent area, because of their own prejudices.
A classic mistake is to purchase an investment property based on an impressive sounding address, rather than the basic fundamentals of investment. I've seen people pay a premium for an investment property in a 'sexy' sounding area where the rental yield is as low as 2.5% on the premise that they're "entitled" to capital growth.... just because they signed a contract.
People who make ego driven decisions usually do so to impress their friends & family, or because they mistakenly believe they’ll achieve better capital growth. Generally speaking these types of properties usually end up being massively negatively geared. It’s not a smart strategy and I believe it’s the underlying reason why so many Australians own only one investment property.
Property investors would do well to ‘leave their ego at home’ when looking to purchase their next property – and in doing so would be able to fund a growing portfolio in the space of only a few years. A smarter way to invest is to focus on affordability.
Affordability is one of the most important considerations in property investing; and is right up there with rental demand and interest rates. Affordable properties are those where 80% of people could afford to rent from you – and where 80% of the population could afford to buy it, if you ever wanted to sell (which you don’t).
Affordable properties are found in the so called lower socio-economic areas; suburbs located further away from the city centre. However, these areas are still well serviced, still have good public transport, good shopping facilities, all the essential services and in many instances great lifestyle benefits as well.
Let’s say an ego driven investor purchased a $600,000 two-bedroom unit 5 klms from the CBD and in a 'desirable' area. They may receive $520 a week rent, and just using the simple interest rate vs rent equation on a 90% loan of $540,000, they’re about $75 a week out of pocket. Council & water rates and strata levies add potentially another $100-$150 to this negative scenario. TIP - strata levies tend to be much lower in the affordable areas.
After five years the 'trendy' property has maybe increased by 15% (and now worth $690,000). However this capital gain has come at a cost - almost $45,500 out of the investor’s cash flow - enough for a deposit for an additional investment.
What's the alternative?
Well this investor could have purchased 3 x two-bedroom units in one of those affordable areas for around $200,000 each. Renting for $280 a week each, they show a total rental yield of $840 a week - compared to the $520 from that unit in that 'trendy' suburb. NB - of course there are council, water and strata levies to consider, along with other costs & benefits to take into account.
Let’s surmise that each of these three properties have only increased in value by only 2% per year (because they're not in those sexy areas) over the five years and are now worth a total of $660,000. However during that period these three units yielded over $218,000 in rental income and because the investor has not had to fund these properties from their own cash flow, he or she has been able to save another deposit or two during the same five year period - so they now have five investments working for them.
You see, buying a property that is considerably negatively geared means you’re hoping and praying that the property will enjoy good capital growth in the coming years to offset the considerable amount of money you’ve been out of pocket week in, week out.
A simple Cash Flow strategy is the direct opposite of that. With a focus on neutrally or positively geared property, it allows you to keep growing your portfolio – and it isn’t unrealistic for someone on a decent salary to accumulate 10 properties in 10 years.
And by electing to have the tenants slowly pay off the principal, you’ll be growing your equity at a faster rate. That sounds a lot more impressive to me than owning one property in a trendy or so-called “prestigious area”.
Instead of focusing on the facts and potential rent, too many people let their ego control their decision - paying more attention to a suburb’s reputation and what their friends might say.
Investors should constantly ask themselves questions like these;
• does my portfolio provide income?
• does my portfolio cost me money?
• is the value of my portfolio growing?
• is my property portfolio helping me to achieve my financial goals?
It’s not about how many properties you own; it’s about what your portfolio is doing for you.
Would you rather own five cash flow-positive properties or five negatively geared ones?