What makes an “investment grade” property?

There are 10.4 million dwellings in Australia and at any time there are hundreds of thousands of properties for for sale.

But not all properties make good investments! 

In fact, in my mind less than 4% of the properties on the market currently are what I call “investment grade.”

You see…over the last few months as our property markets have slowed down, while there is no real shortage of properties on offer, there has been a real shortage of quality “investment grade” properties.

Of course, any property can become an investment property.

Just move the owner out, put in a tenant and it’s an investment, but that doesn’t make it “investment grade”.

To help you understand what I consider an investment grade property, let’s first look at the characteristics of a great investment, and then let’s see what type of properties fit these criteria.

What makes a good investment? 

The things I look for in any investment (including property) are:

• strong, stable rates of capital appreciation;
• steady cash flow;
• liquidity – the ability to take my money out by either selling or borrowing against my investment;
• easy management;
• a hedge against inflation; and
• good tax benefits.

So how do you make money from an investment?

Well…property investors make their money in four ways:

1. Capital growth – as the property appreciates in value over time
2. Rental returns – the cash flow you get from your tenant
3. Accelerated or forced growth – this is capital growth you “manufacture” by adding value through renovations or development, and
4. Tax benefits – things like negative gearing or depreciation allowances.

In my mind capital growth is the most important factor of all, although not everyone agrees with me. 

But, let’s face it…statistics show that most property investors fail.

They never achieve the financial freedom they aspire to and this is, in part, due to the fact that they follow the wrong strategy – many chase cash flow.

Now don’t misunderstand me, cash flow is the ultimate aim goal.

But only once you’ve built a sufficiently large asset base of “investment grade” properties, meaning your investment journey will comprise three stages:

1. The Accumulation Stage – when build your asset base (net worth) through capital growth of well-located properties. You can speed up your wealth accumulation through leverage, compounding, time and “manufacturing” capital growth through renovations or development. You then move on to the…
2. Transition Stage – once you have a sufficiently large asset base you slowly lower your loan to value ratios so you can progress to the…
3. Cash Flow Stage – when you can live off your property portfolio.

The safest way through this journey, which will obviously take a number of property cycles, is to ensure you only buy properties that will outperform the market averages with regards to capital growth.

To facilitate this, I use a 6 Stranded Strategic Approach.  

I would only buy a property:

1. That would appeal to owner occupiers.
   Not that I plan to sell the property, but because owner occupiers will buy similar properties pushing up local real estate values.This will be particularly important in the future as the percentage of investors in the market is likely to diminish
2. Below intrinsic value – that’s why I’d avoid new and off-the-plan properties which come at a premium price.
3. With a high land to asset ratio – that doesn’t necessarily mean a large block of land, but one where the land component makes up a significant part of the asset value.
4. In an area that has a long history of strong capital growth and that will continue to outperform the averages because of the demographics in the area as mentioned above.
5. With a twist – something unique, or special, different or scarce about the property, and finally;
6. Where they can manufacture capital growth through refurbishment, renovations or redevelopment rather than waiting for the market to do the heavy lifting as we’re heading into a period of lower capital growth.

Not all properties are “investment grade.”

O.K. back to my comment that less than 2% of properties on the market are investment grade.

Of course there is plenty of investment stock out there, but don’t confuse the two.

These properties are built specifically built for the investor market – think the many high rise new developments that are littering our cities – yet most of these are not “investment grade.”

They are what the property marketers and developers sell in bulk to naïve investors – usually off the plan, but they are not “investment grade” because they have little owner occupier appeal, they lack scarcity, they are usually bought at a premium and there is no opportunity to add value.

Off the plan apartments make terrible investments!

Analysis by BIS Oxford Economics reports that of the apartments sold off the plan during the past eight years:

• Two out of three Melbourne apartments have made no price gains, or have lost money upon resale. And this is despite a record immigration and a significant property boom.
• In Brisbane about half these apartments bought off the plan are selling at a loss, or at no profit.
• In Sydney it is about one in four apartments bought since 2015 are selling at a loss, or at no profit.

In other words, more investors in off the plan high rise apartments have lost money than have made money.

And of course there are all those investors sitting on the apartments which are continuing to fall in value, but they haven’t crystallised their loss yet.

In 2018, 98,000 apartments were completed across the country and 65,000 in NSW alone, according to ABS figures and the situation is only likely to worsen considering the pipeline of projects still being completed.

According to the BIS research, resales of apartments within a three to five kilometre of central Sydney, Melbourne and Brisbane have realised consistently lower prices than established apartment resales.

On the other hand, investment grade properties:

• Appeal to a wide range of affluent owner occupiers
• Are in the right location. By this I don’t just mean the right suburb –one with multiple drivers of capital growth – but they’re a short walking distance to lifestyle amenities such as cafes,  shops, restaurants and parks. And they’re close to public transport – a factor that will become more important in the future as our population grows, our roads become more congested and people will want to reduce commuting time.
• Have street appeal as well as a favourable aspect or good views.
• Offer security – by being located in the right suburbs as well as having security features such as gates, intercoms and alarms.
• Offer secure off street car parking.
• Have the potential to add value through renovations.
• Have a high land to asset ratio – this is different to a large amount of land. I’d rather own a sixth of a block of land under my apartment building in a good inner suburb, than a large block of land in regional Australia.

The bottom line is buying the right ‘investment grade’ property is all about following a proven blueprint that successful investors follow.

This increases your chance of better financial returns and reduce your risks of getting caught out as our property markets move into the next, less buoyant stage of the property cycle.

It’s not just the property – it’s also about location

By now you would know that location will do about eighty percent of the heavy lifting of your property’s capital growth.

But not all locations are created equal.

Some suburbs will be more popular than others, some areas will have more scarcity than others and over time some land will increase in value more than others.

That’s why it’s important to buy your investment property in a suburb which is dominated by more homeowners, rather than a suburb where tenants predominate.

And you’ll find suburbs where more affluent owners live will outperform the cheaper outer suburbs where wages growth is likely to stagnate moving forward.

But it’s the same all over the world.

Go to any major city – London, Paris, Vienna, Los Angeles – and you’ll find that the wealthy people tend to live within 10 – 15 minutes drive from the CBD or near the water.

Why is this so? The cynics would say because they can afford to.

And in part that’s true.

In general the more established suburbs with better infrastructure, shopping and amenities tend to be close to the CBD and the water and that’s where the wealthy want to and can afford to live, and they’re prepared to pay a premium to live there.

The rich do not like to commute.

Overall, by focussing your research on what those often overlooked owner occupiers are doing, you may just find an investment that outperforms the market and delivers strong value and growth over the long term.

Two-thirds of the market are homeowners

So it’s interesting that while owner-occupiers are one of the most significant influences on property, they are commonly overlooked.

Think about it…with almost 70% of all homes in Australia owned by owner occupiers, this underpins the steady long term growth of property values.

On the other hand, investors, who comprise just 30% of the market, create our property booms (often driven by Fear OF Missing Out or greed) and our property downturns (when they exit the market by sitting on the sidelines or selling up) creating volatility.

Here’s a relatively current snapshot of the national property market according to the Australian Bureau of Statistics (ABS) and CoreLogic:

• There are 10.4 million residential dwellings Australia-wide with a total value of $7.2 Trillion
• Spread across around 15,000 suburbs
• An additional 130,000 to 160,000 new dwellings are added every year
• The total debt against these dwellings is $1.83Trillion (giving an overall Loan to Value Ratio for residential property of considerably less than 30%)
• Residential real estate makes up 52.4% of Australian household wealth
• Investors own around 27% of Australian dwellings by number, and 24% by value.
• There are more than 2 million individual property investors in Australia
• Each property investor in Australia owns an average of 1.28 properties

Now, from these figures it’s fairly clear that owner occupiers comprise the largest portion of the market – in fact, they outnumber investors two to one.

Which is why I always give the following advice to investors who are searching for a strong property performer: buy the type of property that will appeal to owner occupiers.

As I’ve already explained…in my mind an investment grade property must have owner occupier appeal.

 

How do you know which step to take next?

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from Property UpdateProperty Update https://propertyupdate.com.au/what-makes-an-investment-grade-property-2/