Which property is best for you?

By
8/10/2013

With so much conflicting information and advice, how do you choose the right property strategy for you? Chris Gray explains

 

Picking the right property strategy can be overwhelming, especially if you’re asking different advisors. If you speak to a financial planner they may recommend you buy a brand new property, as there are significant depreciation benefits that reduce tax liabilities. Speak to a developer and they may suggest you buy off the plan, which allows you to buy at today’s price and reap the benefits of two years’ capital growth at an average of 10% or more without paying a cent. Or you could speak to an accountant who is likely to suggest buying second-hand and renovating to add value.

 

How do you know which strategy is best? Is there one strategy that works and is guaranteed to build wealth, or does each have its pros and cons relative to your personal situation? And will that strategy still be relevant over time, with changes to your income and attitude to risk?

 

To make the right decision, you first need to disengage the vested interests of advisors to arrive at neutral information. For example, most financial planners will encourage you to buy shares, given their kick-back from the managed fund. If they do get you to buy a property, their recommendation is likely to be from a preferred supplier who may incentivise the transaction with a 2–4% payment. On a $500k property, that’s a $10k or $20k (respectively) payment to the planner!

 

The solution is to find an advisor to whom you pay an agreed fee no matter what investment you choose. Secondly, do your homework. Arm yourself with knowledge so you can spot advice that is really a sales spiel.

 

Here’s my take on some of the potential pros and cons of each property strategy. Review each point with the understanding that these are generalisations and don’t necessarily apply to every property in every sector.

 

Brand new properties

 

The advantages

  • Depreciation benefits - Buying brand new property has significantly more depreciation benefits than buying second-hand properties. You can deduct 2.5% on the building alone for 40 years. This can mean an extra $10¡V20k+ tax deduction that will reduce the tax you pay on your salary.
  • Easy to rent - Tenants love new properties. They rent very well given their clean new looks and shiny new appliances.
  • Latest technology -Another attraction for tenants is the inclusion of the very latest technologies, such as reverse-cycle air conditioning, automatic blinds and remote control lights.
  • Easy to manage - Property managers often jump at the chance to manage new properties as they don’t require the significant time investment for repairs that is often required for older buildings. Having a good property is also likely to attract a better manager.
  • Low maintenance - Call-out fees and labour for minor repairs add up over the life of your investment and can really eat into your profits. Buying new means you are less likely to need repairs, and most items will be under warranty, reducing your yearly ongoing costs.

The disadvantages

  • Overpriced/emotional purchase - It’s very easy to fall in love with a brand new property, as it looks so perfect. An emotional decision might tempt you to pay what the bank will loan, rather than evaluating the property for what it’s worth. No matter how good it looks, if you’ve overpaid it’s a bad investment.
  • Not the best location - Most of the blue-chip suburbs located close to capital cities are already built up, with little land remaining for redevelopment. If there is land available, it will often be very expensive due to the short supply. This means most new developments are in speculative up-and-coming areas further from the CBD.
  • Poorly built - Construction and quality building materials are everything. While most new builds look beautiful on day one, if they are poorly constructed who knows what they will look like in five to 10 years? When buying new, research the builder to ensure the construction is sound and that cosmetic features aren’t in place to hide low-quality workmanship or poor-quality building materials.
  • Rental guarantees/depreciation -  Be wary of properties offering tax efficiencies or rent guarantees. The golden rule on any investment is to never buy purely on the basis of tax, as taxes can change over time with changes in government. Concentrate on how much the investment will make you, not what it saves you.
  • High strata fees - New builds often come with gyms, lifts, pools and 24-hour concierge. While these are fantastic features for tenants, for landlords they add significant costs. For example, I’m currently renting a unit where the rent is $1,400/wk and the strata fees are $500/wk. So my landlord is losing nearly a third of his income in features I’m enjoying.

Off the plan

 

The advantages

  • Buy today, pay later - An off-the-plan strategy works really well in a rising market if you get to buy at today’s price but then settle many years later upon completion of the build when the property has risen in value.
  • Time to save remaining deposit - Off-the-plan properties don’t often require more than a 5–10% deposit, which can ease your entry into investing. While waiting for the build completion, you have the luxury of time to save the remainder of the deposit and learn the money management skills necessary to make the mortgage repayments.
  • Time to increase your income and serviceability - If you’re just starting out in your career, your salary will ideally be rising every year. If you think the market will rise, you might be able to stretch yourself by buying a more expensive property that will be affordable by the time you settle.
  • Zero deposit with deposit bonds -  Making a profit when you finally settle is great, but it’s even better when you haven’t even put a deposit bond down. If you’ve got equity in an existing property, you might be able to access a deposit bond that may only cost $1–2k instead of a $25–50k deposit.

The disadvantages

  • Overpriced - As with new properties, it’s possible to become emotionally influenced by the marketing hype for a new development, which can lead to paying more than the property is worth. Always remember that just because you settle later there is no guarantee of profit.
  • Risk of market falling - There is no guarantee that the property will rise in value between exchange and settlement, and if it falls you could really be in trouble.
  • Significant deposit needed - If you overpay for a property, or the property market falls and the bank values it for less than the contract value, you'll have to fund the deposit and the loss in value.
  • Risks rest of your portfolio - While off the plan can make you a fortune for no money down, when it goes wrong it goes very wrong and poses a serious risk to your whole portfolio

Existing/second-hand properties

 

The advantages

  • Any location - One of the greatest advantages of buying second-hand properties is the sheer number of options available. Second-hand properties are more abundant in established blue-chip locations, and older properties often feature in upand- coming hotspots. Simply put, they are everywhere!
  • Fair price - Mum-and-dad sellers can often be your best chance for picking up properties at a good price. With their limited marketing budgets, they don’t always pay for the best agent, leaving you in a better position to secure the property for the lowest price possible.
  • Solid construction - Properties that have been around for 50 years are often likely to stand for another 50 years if they are well maintained. Most problems will have already come to light, so you know what you’re buying into and can factor costs for upkeep into your budget.
  • Renovate to add instant equity - You can make a profit on a second-hand property even in a flat market by renovating. Even simple cosmetic renovations such as updating the kitchen and bathrooms or modernising fixtures and fittings can boost the appeal of a property and consequentially the price.
  • Smaller blocks -  Second-hand apartments are generally older blocks with fewer apartments. Many tenants and potential buyers prefer to be in smaller blocks as they feel ‘boutique’. Smaller blocks generally have more affordable strata fees, which will increase your cash flow. Fewer tenants also make for easier agreements on general strata issues and building works.

The disadvantages

  • Renovations - Renovations are great for some and a nightmare for others. Many projects cost twice as much and take twice as long to finish, making the work to add value almost pointless as the costs exceed the increase in property value.
  • Maintenance - Second-hand properties that are unloved and uncared for will take more time and money to look after. These properties also rent for less money, reducing your opportunity to build income and pay for renovations and repairs.
  • Hard to motivate other owners - If your block of units needs maintenance, or you can see the potential to add value to it, not all owners will be on your side, and they may not have the budget to put in their share. Lots of buildings are falling into disrepair as owners can’t get agreement or afford the necessary repairs.
  • More active investment - If you’re time poor and don’t have the right property manager, second-hand properties can become a real headache. The solution is to learn how to hire or outsource to the right experts, and budget for these costs.

Reducing the risk

No matter what strategy you implement, there are ways you can reduce your risk. I share my top tips here.

 

  • Get an independent valuation - This is the best tip for buying any property, anywhere in the world. While a $50 online valuation might give you an idea, a full $500–600 valuation, complete with comprehensive property inspection, will almost guarantee you don’t overpay. You can also seek independent valuations for properties that have been built. In this case, the architecture and building plans are reviewed along with corresponding suburb data.
  • Building inspection - If you’re not in the building trade, it’s wise to get a full building inspection of every property before you buy. Even if it’s a unit and the maintenance is paid by strata, you still need to get one done as you’ll share that cost. You may discover expensive concrete cancer that they weren’t yet aware of. 
  • Strata inspection - There are many old buildings that have $50k–100k special levies per unit allocated to repair common areas, such as the external building and doors and windows. If you stretch yourself to take up the investment, these costs could make or break your budget, given that lenders often don’t lend for this kind of building work until completed.
  • Interview property managers - A quick phone survey of property managers can quickly tell you what is in demand from tenants and the rents they are willing to pay. Be sure to ring managers who aren’t connected to the sales agent of the property you are trying to buy. This information can greatly help you plan income and expenditure if you need to make additional renovations to help your asset perform.

The strategy you choose will come down to how much time and knowledge you have, and your attitude to risk and reward. As for my preferences in choosing an investment property, I like buying second-hand in blue-chip suburbs and renovating for the opportunity to add instant equity. Given my experience and ability to balance costs, my profits from a renovation will always cover any losses if I am forced to sell early. It does take skill and contacts, though, to get the right property in the right location and devise the right renovation for the area. Good luck with your new investment!

 

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Comments
  • Alex says on 22/10/2013 09:50:12 PM

    I find it interesting that you rent.

  • Rob says on 22/10/2013 11:14:46 PM

    Why is it interesting that he rents? Its a smart move. Non deductible debt isn't the best investment strategy but for many people they like to own the place they live in, that's a personal choice but not the best one from a financial point of view.

    On the subject of getting a valuation done, only really a good idea when the market is flat or moving slowly. In a hot market like Sydney right now, everything is selling above valuation, you would end up buying nothing and in 18 months you will regret the decision and then when it slows down in Sydney, valuations will start matching asking price but the market will be at the top of its cycle, worst time to buy. Be careful with valuations.

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