While you should never buy driven by your emotions, high-quality investment-grade property in an A-grade location, which you know will provide solid returns and robust capital growth, sometimes warrants spending a little extra money.
This is especially the case when buyer competition is fierce and supply is low as is currently the situation.
Here’s a breakdown of when and why paying a premium for property is a good idea, and how much you should put down.
What type of property you should pay a premium for
When it comes to working out what type of investment property you should consider paying a premium for, it’s helpful to break it down into categories and see how many this property checks off.
Generally, you’re looking for an investment-grade property in an A-grade location as this combo will fast-track you towards financial freedom.
Around eighty percent of your property’s capital growth performance will be due to buying in the right location and the balance by owning the right property, an “investment-grade” property that suits the fundamental demographic in that location.
A property in the right suburb, on a good street and away from a busy road would warrant paying a premium for, for example.
Properties within a close distance of lifestyle amenities and transport are also valuable, as are those in gentrifying suburbs where this will become a reality in the near future.
Good land-to-asset ratio
I always look for property with a high land-to-asset ratio, but this does not necessarily mean a large plot of land…
Well-located apartments have an attributable significant land component under them.
Properties in the right location and with a good land-to-asset ratio would be worth paying a premium for.
Potential for capital growth
I like buying a property where I can manufacture capital growth through renovations or redevelopment rather than relying on the market to do the heavy lifting.
Potential strong resale value
Is the property likely to attract a premium when sold later?
If there’s a strong interest in the property type, for a particular location or if it has a particular style or attributes that will always be in demand, it can be worth paying extra initially, even if you have no intention of selling it, because similar properties that sell in the vicinity will push up the value of your property.
If properties in the area are smaller, but you require more space, a premium may be warranted.
For example, a four-bedroom terraced house, which is not common, can justify a higher cost.
Likewise, properties with a seamless floor plan or one where all the bedrooms are located together in one area are generally more desirable and can justify a premium.
Properties with a twist, which have something unique, special, different, or scarce are generally in higher demand and therefore would make good investment sense, even at a slightly higher price.
Why paying a premium might make good investment sense
So you’ve identified properties that fit all or at least most of the criteria above, but you’re unsure why exactly you should be offering more money than you would do for a similar property or in a similar area.
Capital growth should be the main focus of any property investor (as opposed to cash flow from rental income), at least in the short term before they have built a sufficiently large asset base.
The key reason here is that capital growth isn’t taxed while rental returns are, and as your property increases in value, the rent increase will also generate more cash flow in turn.
Capital growth is a much more important driver of wealth creation than cash flow.
Of course, you need cash flow to allow you to hold your portfolio for long enough so that the power of compounding of capital growth kicks into gear, meaning you must have a financial buffer to see you through the lean times.
That means that if you’re confident in a property’s capital growth potential, it offers a scarcity factor and it ticks all the boxes in terms of location, you can and should justify paying a premium to secure it.
When it comes to growth potential, you then know that this type of property will appeal to a wide range of affluent owner-occupiers, and will continue to be in high demand.
How to calculate how much premium to offer
While it’s often said that you make your money when you buy your property, that’s because you buy the right property, not because you buy it cheaply.
The trickiest part of paying a premium for that great property is working out how much to offer.
Especially since it’s really hard to ascertain market value for unique properties.
You need to ensure you strike the right balance between a price that aligns with the market but that also meets future growth trajectories and market changes.
While it’s sometimes hard to calculate the premium for an off-market property as these transactions lack transparency, auctions give buyers transparency and full visibility of the competition and what they’re willing to pay.
Here, any premium paid is genuinely a result of competing parties – visible market forces determining fair value.
Exactly how much to offer will depend on the value of the property, asking price and expected growth trajectory.
The key message
When it comes to paying a property premium, there will be times when it is not worth adding extra value to a property purchase.
Avoid buying out of panic or fear, when using your emotions, under pressure or if your finances can’t stretch that far.
But if there is an investment-grade property in an A-grade location that piques your interest, you’ve done the research and understand its growth potential, it is valuable to offer a premium in line with market value and your projected value.
In this case, paying a premium makes excellent investment sense.
That’s because a property bought today for a premium might ultimately look like a bargain with several years of capital growth.
So, what's your investment strategy?
Most investors start with "the property" and that's actually the wrong way around.
Just to make things clear...buying an investment property is NOT a strategy!
It's important to start with the end game in mind and understand what you need and what you want to achieve and then you have to build a plan to get there.
The property you eventually buy will be the physical manifestation of a whole lot of decisions that you will make, and they must be made in the right order because property investment is a process, not an event.
The problem is that most people become property investors without putting much thought into it.
You’ve heard it before – failing to plan is really planning to fail.
On the other hand, strategic investors devise a strategy – they bring their future into the present and devise a plan to achieve the results they want.
When you have a Strategic Property Plan you’re more likely to achieve the financial freedom you desire because we’ll help you:
- Define your financial goals;
- See whether your goals are realistic, especially for your timeline;
- Measure your progress towards your goals – whether your property portfolio is working for you, or if you’re working for it;
- Find ways to maximise your wealth creation through property;
- Identify risks you hadn’t thought of.
And the real benefit is you’ll be able to grow your wealth through your property portfolio faster and more safely than the average investor.
Your Strategic Property Plan should contain the following components:
- An asset accumulation strategy.
2. A manufacturing capital growth strategy.
3. A rental growth strategy.
4. An asset protection and tax minimisation strategy.
5. A finance strategy including long-term debt reduction and…
6. A living off your property portfolio strategy.
What's worse than having no strategy? Having the wrong one
Residential real estate is a long-term, high growth low yield investment so your strategy should be to use the capital growth of your property portfolio to grow a large asset base that will give you more choices in the future.
But many beginners chase cash flow or the next hot spot or try to make a quick profit by flipping.
Others chase tax benefits because they think negatively gearing new properties will “keep their tax down” so they buy a new house in an outer suburb or put a deposit on an off-the-plan unit due for completion in two years’ time, because of the higher depreciation deductions on offer.
The problem is that these properties just don’t offer the capital growth you require to grow your wealth.
It’s an investment disaster!
And then almost as bad as… changing strategy.
Unfortunately, some investors get spooked when markets soften and rather than sticking to a proven strategy to secure their wealth creation through capital growth, they opt for something cheap and supposedly cheerful instead.
Rather than looking at what has “always worked” over the long term, they look for “what will work now.”
It’s no surprise then that their smiles turn into frowns when that inferior property underperforms down the line.