There’s a well-worn philosophy on investing that I‘ve seen rolled out time and again by some advisors.
It suggests investors should try and buy the best-quality, highest-priced, blue-chip property they can afford as close as they can to a major CBD.
The reasoning behind this thinking is that near-city locations see the strongest capital gains, and that’s what you need to achieve long-term financial security.
While I understand the fundamentals, there’s a big problem I see with this approach… it’s far too simplistic and totally restrictive.
My concern is there’s a whole group of investors saving feverishly (and often unsuccessfully) to put together a huge deposit for that property in a plush suburb. They’re convinced this single big-ticket investment is their path to riches.
Sadly, while they’ve been trying to get their funds together, they’ve missed out on a huge pool of excellent assets that could have had them earning great returns in currently hot markets.
Here’s why I believe it’s better to start small and finish big.
Bigger is not better
Why do people believe bigger is better? They’re convinced if they invest a huge chunk of dollars in a holding, the dividends will mount up thick and fast.
But you must understand, just because a property is expensive doesn’t mean it’s investment grade.
Let’s say you want to purchase in a suburb five kilometres from a CBD where the median house price is above $1 million, but you only have a budget of $650,000. Fortunately, you’ve heard about a two-bedroom house that’s within your means! Happy days!
Well, slow down tiger because there are a few compromises to make. The two-bed house is a pre-war home that’s in original condition. It’s on a tiny block of land fronting a busy main road with no reasonable car access due to steep topography. It faces west and contains one bathroom. Its pre-war construction means it can’t be demolished or extensively developed, and the adjacent 24-hour petrol station sees traffic and noise all night long.
You get the idea. Buying a substandard investment in a blue-chip location is a massive mistake.
Instead, think about the balance between location, position and dwelling type. A new, detached home a bit further away from the CBD will meet your budget. It could also be in an area with both strong rental demand and a high proportion of owner-occupiers. New transport infrastructure and nearby services and amenities will ensure it has a wide market appeal. This property is set for great capital gains – and all for $550,000.
Choosing your asset based purely on location is a fool’s errand that can quickly see you come undone.
Capital gains vs. Cashflow
A further consideration is that, with real estate investment, there’s usually a trade-off between capital gain potential and cash flow.
When you get a lot of one, you only get a little of the other.
Many inner-city locations have great capital gain potential, but the cash flow – or rental yield relative to your invested amount – is a pittance. How are you supposed to service a loan and take care of rates, fees, repairs and maintenance if your rental yield is just 2.5 per cent gross!
Finding the right balance between capital gains and cash flow based on your personal financial situation is important. Having a strong yield means there is enough coming in the door each week to help you stay ahead of costs. This allows you to hold onto the property stress-free for the long term. The result will be ‘time in the market’ which is the best formulae for value gains.
Having a great property in the inner city does you no favours if the bank ends up foreclosing because you couldn’t make your loan repayments.
An essential pillar of successful investment is diversification, and this can be achieved in many ways.
Firstly, having multiple small properties instead of a single big expensive one mitigates risks around emergency costs. Let’s says a hot water system blows up in one of your four investment properties. That means just 25 per cent of your income/costs will be affected.
But if you tip the entirety of your funds into one asset, and it’s hit with a catastrophic event, you could be in real trouble. For example, if you need to move a tenant out during repairs, you’ll lose 100 per cent of your rental income.
The other thing to diversify is location because different markets move at different speeds. While one area is rising in value, another will be stagnating. By holding assets across a range of locations, you reduce the risks of buying in just one dud spot while boosting your chances of picking a booming suburb.
The other advantage of diversification is liquidity. Having many affordable assets gives the flexibility to sell down just one or two if needed. You can also decide which ones will be used as security when you’re applying for loans. This means you don’t have to encumber your entire portfolio because you only own one asset.
Here’s a final advantage of locational diversity that’s often overlooked. Borderless investment can see you purchase property across many states and territories. The upside here is that land tax is a state’s-based levee. Land tax kicks in once you exceed property value threshold limits based on the total of your holdings within that particular state. By investing across different states, you can stay below the relevant thresholds, thus avoiding land tax and saving yourself tens of thousands of dollars.
So don’t get caught up in the ‘blue-chip-at-all-costs’ mentality hype. By choosing the right kind of property and following a well thought out strategy, you can accumulate multiple assets at affordable price points that will grow and compound in value over the long term.
Always review any property location research and investment analysis data, with a professional, QPIA (PIPA Member) qualified & accredited ASPIRE Property Advisor Network Advisor. Never rely on glossy sales brochures or property marketing information, ensuring a property is right for your strategy. Property Investing is about BUYING a property that matches your goals and aligns with your investment strategy, never be SOLD an investment, know your numbers!
Visit www.aspirenetwork.com.au or call our office to be connected with an accredited and independent Property Investment Advisor on 1300 710 933.