As our economy moves forward and a new property cycle begins, fortunes will be made by some investors. But if history repeats itself, many property investors won’t get the financial independence they deserve, so I want to share my time tested golden rules of property investing so you have a roadmap to help you through the next property wave.
Even though they think they are investing, many property investors are actually “speculating.” They buy a property emotionally, often near where they live, where they holiday or where they want to retire and then hope or pray that the market will appreciate. They are totally dependent on outside market conditions to produce a profit.
Smart investors do it differently. They make educated investment decisions based on research and buy a property below it’s intrinsic value, in an area that has above average long term capital growth and then add value creating some extra capital growth. They never invest in anything they don’t understand. During the boom years investors’ hunger for returns took them into exotic terrain, such as property options or development. Promoters often promised large profits using opaque schemes, which often led to significant losses.
During the boom many investors forgot the age-old property fundamentals of buying the best property they could afford in a proven location. Instead they got sidetracked by glamorous finance or tax strategies; and some lost out.
While the argument about capital growth or cashflow will rage forever, there is no doubt in my mind that the only way to get true riches from real estate is through capital growth. The major factor affecting capital growth in property values is the relationship between supply and demand.
While most investors recognize that land appreciates in value, it’s not as simple as that. Not all land is made equal and not all land appreciates at the same rate. In the outer suburbs of our capital cities there’s lots of land (ample supply) and much of the demand comes from a small segment of the market – first home buyers (restricted demand). This keeps a lid on capital growth and makes these areas poor investment prospects.
Another factor that makes properties in these areas poor investments is the low land to total asset ratio. Usually land only makes up around 50% of the total value of the property (e.g. the land component may be worth only $200,000 of the total house price of $400,000).
In the inner suburbs, the proportion of the land value to the total property price is usually considerably higher; and remember it’s the land that is scarce and increases in value. Also in the inner and middle suburbs of our major capital cities, there is strong demand from a wide range of owner occupiers yet there is restricted supply. And as most of the land is already built out, there is limited scope to increase the number of dwellings.
Not all properties in a given suburb will make a good investment or have similar capital growth. Even if you never intend to sell it, for your property to appreciate in value strongly it will need to appeal to a wide range of owner occupiers who make up the vast majority of buyers. That’s why I suggest you avoid studios, student accommodation, holiday accommodation and serviced apartments. When a valuer assesses your property they will want to see it have broad market appeal.
Long-term demographic trends (where and how people want to live) will determine the type of property that will be in demand in the future. As our cities mature there will be more single and two people households meaning that secure medium density apartments and townhouses will be in strong demand.
7. Surround yourself with a great team.
8. Understand where the risk really lies.
Most investors believe there is a direct relationship between risk and reward – the higher the reward the more the risk must be. But that’s just not true. While property development is risky for most investors, it’s not risky for me as I have completed hundreds of development projects. However investing in shares is risky for me – I always seem to get it wrong.
While most investors think the risk lies in the property or the market – factors outside themselves – I would argue that that the biggest risk investment actually lies with you – the investor. The best defence is a good offence and by educating yourself and developing a level of financial fluency, you can make your investment journey as safe as houses.
That’s why most successful investors don’t diversify. They specialize by becoming good at one thing, or an expert in one area or niche and reproduce the same thing over and over again getting great results.
During a boom everyone is an optimist and expects the good times to last forever, just as we lose our confidence during a downturn. Our property market behaves cyclically and each boom sets us up for the next downturn, just as each downturn paved the way for the next boom, as it has over the last year.