‘Don’t judge a book by its cover’ is just as true in astute property investment as it is in life. Property investors must look past a property’s appearance to see the real returns.
Blogger: Simon Pressley, Propertyology
The innate human tendency to form strong, often lasting, opinions based on an initial visual interpretation of something—the ‘first impression’—can often get people into hot water. Especially when they act on what their eyes tell them rather than use their rational brain. Letting our first impressions cloud our judgement is especially fraught in property investment. Over-emphasising the visual at the expense of the practical is a common pitfall that has seen many new (and plenty of experienced) investors lose hundreds of thousands of dollars in returns over time.
Psychologists call the phenomenon of making positive assumptions about a person or thing’s character (or value) based on its appealing visual presentation the ‘halo effect’. A person judges what they see within the frame of reference of their first impression and tend to cluster characteristics together within that context. So, if they like what they see, they tend to have a favourable bias towards it. When it comes to property, if a potential investor likes the look of a place based on its aesthetics, they will tend to assess its other attributes, such as future capital growth, positively. In other words, they will persist in seeing it in a good light and tend not to think dispassionately about it. This can be a big mistake.
As a property investment advisor, I see it all the time: investors prioritising visual appeal over crucial economic considerations. The ‘touch and see’ nature of property is very seductive (and is a major reason why so many investors pursue property over less tangible investment alternatives, such as shares), but trouble comes when what a property looks like becomes more important to the purchasing decision than what the property can return.
Four pointers for being practical
To win with property, you have to look beyond its beauty and see the real deal. You have to view property as a financial instrument and evaluate economic growth potential. It can’t be a superficial decision. Think about it: the difference between 6% and 8% average capital growth per year on a $450,000 property equates to $165,000 over ten years. That 2% is well worth thinking rationally, but how do you do it when a favourable first impression is tugging on your heartstrings? Easy:
1. Step back and look at the property market from a macro level – Australia is a big place.
2. Don’t analyse a property for its bricks, mortar and what’s within its walls. An astute share investor would not buy stock because they like a company’s logo or products. And so it is with property: don’t buy a property because you like using flick-mixer taps or hanker after a heritage facade. Think about what happens when the inevitable wear and tear reduces the property’s good looks. Ask yourself how important are caesar stone bench tops or mirrored mosaic tiles?
3. Look at the property’s projected long-term capital growth and its potential within the context of the local economy, population trends, where the governments of the day are leading us, supply and demand, and other important indicators of a good investment decision.
4. Realise that, as an investor, your objective is not to buy the nicest looking property; it is to maximise the return on your money. The property’s aesthetics will have some impact on its going price now, but will have negligible effect on how the property performs in the future.
Location, location, location
The ‘noughties’ decade saw property values increase at unprecedented rates world-wide. We were also bombarded with property information from the internet and a tonne of lifestyle and home improvement shows, often screaming the message: ‘location, location, location’. Understandably, a lot of people ran with that message and assumed a ‘good’ property buy was one in a ‘good’ location. But what actually constitutes a good property investment location? Unfortunately for many people, they judged a good location to be one in which they could see themselves living and purchased property for its popularity given the schools, shops and cafes nearby, its proximity to water, the attractiveness of its view or the general aesthetic or ‘look’ of the property.
If these criteria were the sole drivers behind their investment decision, then the investor undoubtedly overlooked much more crucial considerations. For instance, there are always factors such as these at play:
• Queensland’s Gold andcoasts offer some of the best lifestyles in the world, yet their unhealthy reliance on tourism, combined with a very high Australian dollar, have rated them among the worst performers in Australia for the past few years.
• The investment performance of apartments in large complexes (offering modern fit-outs and views) have been significantly less than those of well-chosen older apartments in smaller complexes in the same areas.
• Popular inner-city Melbourne locations have enormous volumes of new residential development, which has been creating an over-supply and limiting value growth in those locations for some time.
• Sydney too has numerous suburbs which are pleasing on the eye and housing under-supply. Sydney also has the worst traffic issues in the country, cost of living pressures, and unaffordable housing: all important issues which influence the decision of thousands of people who relocate away from Sydney each year.
When locations such as Brisbane produced an average increase in median values of 11% a year during the last decade, most people would have made significant money regardless of the property they purchased. But this current decade is a very different ballgame. Inactive governments, a retracting construction sector, and tighter immigration policy are all in play. Persistent media reporting of uncertainty around some international economies (for example, the ‘Eurozone’ and the US) is likely to continue for some time and will do little to instil confidence in Australian consumers (even though I think we should be optimistic because of Australia’s strong economic fundamentals and our alignment with a booming Asia).
There are 9.1 million residential properties in Australia and some great investment opportunities on offer. But investors can’t let the unprecedented results of the last decade lull them into a false sense of security. The days when investors could buy on gut-feel and watch their property double in value over the subsequent decade are gone. Skill in property economics is needed to find opportunities. And that skill isn’t about spotting a good-looking property or a restful waterfront location. Driving around an area on the weekend, looking for cafe strips, streetscapes, or proximity to train lines does not constitute ‘property research’. Spending a few hours on the internet to see which properties take your fancy will not cut the mustard either. Selecting a suburb for its visual appeal and then diving headlong into buying a property there because it looks ‘good’ is wrong thinking. All this will very likely result in limited returns and a rude awakening!
There is only one way to avoid the halo effect in property investment: see the big picture, find out the facts, evaluate the economics of the opportunity and—for heaven’s sake—look past the pretty.