Identifying Poor Property Investments

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When it comes to identifying poor property investments, many people can get caught up in the hype of the promises of “quick returns” or believe and trust figures that look too good to be true. 

So you’re left with a balance of trying to find the best investment strategy that suits you, whilst avoiding the many pitfalls investors can encounter. 

The Right Investment Strategy

This is where the problem lies for many. There simply isn’t one single “right investment strategy” for everyone. Choosing a successful strategy should come down to your personality and, to end with the most positive result, the following should be taken into consideration:

• Your attitude to risk

• Time availability

• Skill

• Current financial circumstances

• Access to experts (financial planners, accountants, mortgage brokers, etc)

As you get older, a lot of things change. Your income, family commitments and health just to name a few. Just as these change, so should your property investing strategies. 

And that’s where things can get confusing. Because there is no “right strategy”, a lot of unscrupulous “advisors” can try to steer you toward investments that are designed to line one person’s pockets… and it’s not yours.

Red Flags

Over my several decades of property investing and having interviewed hundreds of Australia’s leading experts on my Sky News Business television show, I’ve become accustomed to spotting red flags in a hurry. However, many of them are simply not obvious for new investors. 

All the successful property investors I know made their money over a very long period of time, focussing on “time in the market”, rather than “timing the market” for a vast majority of their portfolio. Of course, that’s not the only way to make money from property, though it’s certainly the tried and true method I see among most successful investors I know.

So with that in mind, let’s take a look at five red flags to help you identify poor property investments that you absolutely must be aware of.

1- Relying on Hotspots

You’ve probably seen all these hyped up ads on social media spruiking the virtues of “hotspots”. Unfortunately, in all my years of experience, the only people who seem to make money from buying in hotspots are either speculators who get extremely lucky, or those making commissions on properties sold in those hotspot areas.

Seriously, if someone was so confident that a hotspot was going to increase in value and so good at finding those areas, then surely they'd already have made enough money to afford to retire to their $1 million yacht in the Maldives, right

The problem with hotspots is that people get excited seeing the opportunity to make 20 to 30% capital growth in a year. And to be honest, who wouldn't?

The reality is though, that there are huge risks involved in this type of investing. I've had countless people come up to me in the past and tell me how they fell for the hotspot sales pitch and the lure of big returns.

Some see the investment stagnate in value over a long period and then cost vast amounts of money to sell. Or much worse for others, where the property tanks in value because of external factors, or unrealised industry and infrastructure in the area.

To succeed in “hot spot” investing, you need to remember the following costs:

• Entry costs: Stamp duty and legal fees can add up to 5-6% of the purchase price.

• Exit costs: Agent fees and marketing are another 2-3%.

• Capital gains tax: Short-term profits can be heavily taxed.

This means you need substantial growth just to break even. If you mistime the market or the boom never happens, then what? 

Questions to Ask

If you ever find yourself even thinking about a “hot spot” investment, ask yourself these questions:

• Why am I buying in this area?

• What are the growth drivers and how likely are they to happen?

• What happens if growth doesn’t occur?

• What’s the worst case scenario?

• What is my exit strategy?

• How great is the risk?

• Is the potential return worth the risk and potential exit costs?

  
  

Get Expert Advice

If you’re not a full-time property investor, I suggest you lean on experts to help in your journey. Reports from https://www.hotspotting.com.au/ or https://www.corelogic.com.au/ can provide valuable insights and help confirm your decision. If you’re not willing to spend a few dollars on reports or professional advice, why would you be willing to risk hundreds of thousands of dollars on speculative investments?

2- Rental Guarantees

Although this system is not as popular as it once was, I still see it occasionally advertised online. 

It plays on the fear that as an investor, your property might remain vacant for a period of time. Then if that happens, how are you going to pay the mortgage?  

Solution? What about if you could buy a brand new property that offered a “rental guarantee” for up to several years? Surely that would solve the problem?

In principle, a rental guarantee sounds like a good idea, though here is how you can actually end up paying more.

Let’s take a look at an example with a rental guarantee of 3 years, assuming identical properties that will be the same value after those 3 years:

The Example Property as a Comparison

Fair market value of the property: $1,000,000

Normal rent (adjusted to factor vacancy rates): $800/week

The Rental Guarantee Property

Same Property with Rental Guarantee (you are charged an inflated price): $1,050,000

Rental Guarantee: $850/week

Overpayment on the property: $50,000

Additional rent received: $50/week ($7,800 over 3 year guarantee)

The Buyer’s Loss

$1,050,000 (price paid) - $1,000,000 (actual price of property) + $7,800 (additional rent received from rental guarantee)

= $42,000 loss

The Final Blow

This is the really important part to understand. Some rental guarantees are offered by "shell companies" with no real assets. There are countless stories of people purchasing these properties, only to see the company supplying the “guarantee” collapse soon thereafter. This can leave buyers without any rental guarantee at all after already overpaying for the property. 

Important Note About Rental Guarantees

I'm not saying that all rental guarantees are a bad deal, or that you are certain to be ripped off. You just need to be aware of the risks before you sign anything.

If you manage to buy a property at a fair market price and then get a rental guarantee on top, then that's a great bonus.

Rental guarantees though, should never be the primary reason for investing. The underlying property and its location is always the most important factor. 

Here are some questions you must consider:

• Once the rental guarantee is over, what is the chance of continuing that sort of rental return in the future (and what are the vacancy rates)? 

• What would be the expected capital growth for the area in the long term?

• If you plan on exiting after the rental guarantee, what will be your costs associated?

If you buy a property in a great location that ticks all the investment boxes, you will rarely need any sort of rental guarantee anyway as people will always want to live there. 

3- Buying in One Industry Towns

Location, location, location. We’ve all heard it before.

Location is certainly one of the biggest factors in determining how a property investment portfolio might perform. Just remember though that property is a long term investment and there are also high buying and selling costs associated with it. Therefore it's crucial to think about how a location is going to fare over time. 

A massive risk is if you buy a property that is in an area reliant on a single industry (or riskier still is if it’s a single company), such as:

• Mining town

• Tourist town

• Location manufacturing plant

If that industry slows down or falls over, the local economy can fall apart in a hurry and with it goes the value of your property. 

Sure, there are savvy investors that might have expertise or inside knowledge about a particular industry or area, though for mum and dad investors, this simply isn't the case and it's just not worth the risk. Even those with inside knowledge tend to balance the risk of their portfolio and only allocate a very small percentage of it to speculative investments anyway.

If you're not an expert or a full time property investor dedicating your career to the craft, a far better option is to invest in more stable property, in more stable locations.

Blue chip property is purchased in areas that are generally 5 to 15 kilometers from the CBD, where there are many industries supporting the local economy and driving residential demand. 

In these areas, there is far less speculation and a much lower chance of the market being subject to change from a specific factor.

4- Sold Predominantly to Investors

It doesn't matter whether you're interested in buying a brand new property or something that is well established, there are generally buildings in all areas that typically have owner occupiers, investors, or a mixture of both. 

Here are the pros and cons of each type of owner:

Owner occupiers

• As they live there, they generally take good care of the building

• They are less likely to sell in a market downturn or financial crisis as they still need somewhere to live, which protects the value of the complex to a certain extent

• Although they might want to take good care of the property, they don’t always have funds to look after the building, or want to put money into adding cosmetic value to make it more appealing. As the age of residents increases, buildings can easily fall into a state of disrepair

Investors

• When the financial squeeze is applied, investors will almost always sell their investment properties before they sell their family home

  • If a property is sold (or rented) under true market value (in this case it might be a “distressed sale”), then this can affect the price of every property in the building

• Investors can be highly geared and thus not want to re-invest more money into a strata if they don’t need to. This can result in the building falling into disrepair, especially when they are not looking at the building on a regular basis and are not familiar with its condition

  • Conversely, investors might also be keen to target properties in need of repair as small investments by owners can also yield significant jumps in capital growth, building fast equity in the property

There's no right or wrong answer here and I'd suggest a lot of it is dependent on a case by case basis. I personally like to see a balance of investors and owners to balance out the reasons mentioned above. 

5- Large Gap Between the Price of an Equivalent Second Hand Property

Understanding the value of a brand new property can be hard. I've seen cases where developers have put new properties for sale in the same street, with asking prices varying in value by 6 figures.

Even if you have a large complex and 100 properties have been sold in the building already, it doesn't mean that they're all worth that amount. There's always a possibility that some unscrupulous property spruiker has sold most of those properties to unsophisticated amateur investors that just assumed they were buying well.

The best way to get an idea of whether you're paying too much is to see what a renovated second hand property is selling for (or better still, has recently sold for) in the same area. Then you can see how much of a premium that you're paying if you decide to buy brand new.

You might make a very different decision if you discover that a brand new two bedroom unit in a large block with high strata fees, was costing the same as a three bedroom house on a reasonably sized block of land just around the corner.

Brand new properties might still have a lot of allure for investors, especially when it comes to the benefits of depreciation, though my primary focus is on the spreadsheet that shows me long term historical (and future) ROI, as well as which property is going to have higher demand over the long term.

How Do You Make A Decision?

Don't get me wrong, I've made plenty of mistakes in my career as a property investor. The only way I’ve learned in many cases is by actually doing it for myself. The beauty of education and actual experts available these days is that you don’t need to make the same mistakes too. There are a lot of mistakes that I see many other people still make that are easily avoidable. 

The best thing to remember is that you should do your own research and enter the process with your eyes wide open.

Just because someone says something is true and shows you a fancy graph doesn’t mean you should believe it. Do your own due diligence and make sure you always consult genuine experts before making decisions. 

For myself and our clients, property investing is a marathon, not a sprint. I believe in buying and holding blue-chip properties for the long term. It’s not sexy. There are no bells and whistles. You just need to get started.