While property is a reasonably safe investment, there are also many ways you could lose your hard-earned cash. Sam Saggers lists his top 8 riskiest strategies to avoid in 2014
1. Lifestyle investment in coastal areas
The illusion that a beach area is a formidable purchasing concept is flawed. Many choose these areas because they are wonderful lifestyle areas, yet most of these areas lack simple community infrastructure that inspires growth.
They have no real market drivers. Often they are actually retirement and small tourism communities. They have little prospect for long-term performance. The assumption that every water way is the next Sydney Harbour is wrong.
Many new property investors or homebuyers run with this notion and are trapped in a non-performing asset for many years. That isn’t to say that all waterfront areas are poor but these areas always have an economic underbelly rather than the speculative cultural hope of change.
Why you shouldn’t invest in one
Typically, lifestyle locations tend to have little or no growth in industry, which is needed to create jobs.
- They tend to have a lot of supply, which drives down rental yields and house values.
- Many coastal areas are dependent upon highly cyclical industries or industries which are heavily dependent upon economic factors such as tourism and retail outlets.
- Finance issues – many banks issue restrictions or won’t lend on coastal area properties.
Many outer ring suburbs of major metropolitan locations offer affordable price points; yet deliver good yields and solid growth.
2. Mining towns that are “one trick pony” areas
A “one trick area” simply means locations with only one major industry. The influence that the biggest mining companies have on world markets is profound, let alone what their activities can do for local Australian property markets.
Over the next decade, trillions of dollars will be made from mining in Australia. Many assume the infrastructure and job security that the mines bring are a growth driver yet the influences are completely external to the market. Many markets are solely
dependent on the miners’ activities, making these markets very risky. If the mining company remove themselves from area, house prices could fall sharply.
Why you shouldn’t invest in one
One word – risk! We have seen that small single industry mining areas are not great investment opportunities for the long term.
Towns with a variety of industries whose growth drivers are moving in the right direction. Bigger service centres are much better areas to invest.
If the town is not in the top 20 biggest Australian cities in terms of population and economy, you need to ask yourself, is it the best place to invest your hard earned money? I once coined the phrase – “mining markets are crack cocaine for property investors” and I stand by this. They are an addiction. People chase yields with little thought around the downside risk.
3. Ineffective joint ventures
A joint venture allows a group of individuals to work together with the intention of obtaining a specific outcome. As unique as the individuals undertaking them, joint ventures can involve many different goals and required actions to achieve their stated purpose.
In terms of property investing, it’s not uncommon to see family members pool their resources to obtain a property or number of properties that each person could not purchase individually.
Why you shouldn’t do it
Joint ventures are a great way to buy investment properties, however only if they are set up and managed correctly. Common problems include:
- Lack of a well-defined goal. A goal should include the purpose for the investment, such as a short-term profit or long-term growth.
- No allocation and accountability process. Each joint venture should have clear goals, complete with expected actions from each member of the joint venture. For example, every member should know who is going to be responsible for contacting council and who will arrange to meet with the finance brokers etc.
- Lack of legal documents. This holds true especially when the members of a joint venture are family members. Without legal documentation, establishing what is expected of each member is tenuous at best.
Have clear expectations of what you want the joint venture to do - who is expected to do what - and treat the process like a business decision - because that’s exactly what it is!
4. Cross securitising
Cross-securitisation is, simply put, when a lender uses all of your properties as collateral when extending finance. In other words, all of your properties are under one or more blanket loans with one lender.
Most banks have clauses in their home loan documents that entitle them to review any one of your home loans with them at any time and ask for additional funds. This can happen if the bank believes that the value has decreased or that your debt has climbed too high.
This clause also entitles them to force you to use any other of your properties as security in order to provide the bank with the additional funds necessary to re-secure the loan in question. In other words, all properties are security for all loans. This can severely limit your investing future.
Why you shouldn’t do it
The following are just a few of the many reasons to avoid cross-securitising your loans:
Why I wouldn’t invest in one
- Your ability to borrow is tied down if all of your properties are financed with one lender. If, for example, you want to borrow more than 80% the premium for the LMI is calculated on all of the money you have with that lender, not just the amount you’re currently seeking. This adds thousands to your borrowing costs.
- If you want to sell off one of your properties and keep the equity you’ve earned, the lender could require that you use all of the money you gained from the sale to repay your debt rather than allow you to only pay off the portion that was secured by the property you sold.
- The “all monies” clause (which most loans have) gives your lender the option to re-assess the risk you present to their interests at any time. For example, let’s say you want to borrow to purchase a new property. The “all monies” clause gives the lender the ability to revalue all of your properties, risking the possibility of properties with lower valuations offsetting those that are higher, resulting in a significant reduction in your available equity.
- Better choice
Spread your loans among a variety of lending institutions. This gives you much more flexibility in handling your finances. You’ll have the ability to choose which properties you want to strip equity from which can be put towards continuing to grow your portfolio.
5. High strata cost property
When you purchase a unit, you’ll likely be required to pay into the body corporate fees (also known as a strata scheme) which typically covers the following:
- Building maintenance - on both the inside and outside of the structure.
- Building insurance
- Upkeep of the gardens and other common areas
- Upkeep of the swimming pool, tennis court, gym and other communal features
- Communal electricity
- Sinking fund costs
Very high strata costs can quickly erode any cash flow the unit may give you, seriously impeding your ability to buy more properties. Beware of bells and whistles that add to the cost. Gyms, pools, steam rooms, lifts and doormen all cost money. Beware of these added costs. The cost will outweigh the benefit.
Should you choose to purchase a unit it’s very important to include strata costs when calculating the feasibility of a property investment purchase. A good rule of thumb when estimating strata costs:
6. Buying at auction in a bull market
- Large properties with all of the bells and whistles will cost from about 0.7% to 1.2% of the purchase price
- Townhouses and properties with just the basics should have strata fees in the range of 0.4% to 0.7% of the purchase price
A bull market is a strong market, where demand for accommodations exceeds the supply of available properties. Sellers in this kind of a market are confident that they will receive the amount they are asking for, hence why so many choose to sell their property at auction.
As many potential buyers bid against each other, the amount the vendor will receive potentially will meet or exceed the figure they’re asking for. If auction clearance rates are over 75%, you should wait to buy. There is too much pressure on pricing.
<subheader>Why you shouldn’t do it
As a property investor, your focus is not on acquiring a property at all costs, rather it is to buy a property in the right location, at the right time and preferably at a discount, use add value strategies to increase its value and then manage your cash flow and your portfolio to maximise your returns.
When you buy at auction during a bull market you are buying at the top of the property cycle, which means you’re paying top dollar for a property. When the market begins to trough, as it typically does after a high, your property may lose value and eat into any gains you may have had. This will have a huge impact on your ability to continue to growing your portfolio.
Search for emerging markets and buy at the bottom of the market. What you need to look for are great growth trends such as:
7. High population growth and high land supply areas
- Supply and demand
- Low supply of housing stock coupled with increasing need for housing
- Diverse mix of industries, good transportation options, shopping, entertainment and schools.
- Population growth
- Growing, not stagnant and not effected by supply of new land.
- Infrastructure spending
- Increase in both public and private spending on infrastructure projects which is keeping up with growing population
- Look for growth in wages, gentrification and rising house prices
- Yield variation
- Calculated by dividing the total rents for the year by the sales price. Look for the sweet spot of about 6%
Growing population in an area where lots of land is available for release. Controlled closely by governments and planners. Remember, governments want to see an affordable house price for the masses and investors want to see rising house price and low supply. You need to understand the difference.
Why you should be wary
The greater the supply of properties, the lower the rental yields. Markets with these features won’t deliver the returns you need to grow your wealth.
Sometimes areas where there are high population forecasts are actually the worst areas to invest. The state governments often identify this growth through town planning so will keep housing affordable by releasing land. The more land identified for release may mean the population increase is a zero sum effect. It’s a fine line balance of land and population.
Look for locations where there is a limited supply of land available for development. When combined with strong economics, population growth, rental yield, demographic and infrastructure drivers, properties in these kinds of areas tend to deliver much greater returns than areas with an adequate supply.
8. Buying because you love it!
We tend to fall in love with our properties. That’s a normal human emotion, however as property investors we must learn how to lay aside our emotions and let the numbers do the talking. If a property doesn’t stack up numbers wise, it’s time to move on and look for something that does.
Why you shouldn’t do it
Our emotions don’t make good business sense! When we buy with our emotions we are putting our feelings ahead of what the market is doing. If, for example, we fall in love with a property that happens to be in a market that is at the top of the property clock - in other words it’s at the peak of the market - we’ll be sorely disappointed with our returns as the market begins its natural decline into a trough.
It’s better to let the math make the decisions for us rather than our emotions! If we see a property that we simply must have, before doing anything, get the advice of a third party - someone who is completely non-biased and who is knowledgeable about investing in property. Sometimes all it takes to help us “cool our jets” is a cold dose of reality delivered by someone else.
Sam Saggers is a prolific property investor and the CEO of Positive Real Estate Group. For more information, visit www.positiverealestate.com.au
All views expressed are solely the author’s. Make sure you do your own due diligence and speak to a qualified professional person before making any investment decision.
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