How to successfully pick an investment property

Many individuals seek professional help when investing in stocks. This may be full service through a financial adviser. It may be using investment research like Morningstar Investor. Or you might be knees deep in a Discount Cashflow model and attending factory tours – or giving ChatGPT a spin.

Less common is involving professionals in investment property purchases. As an asset class they are complex, and they are expensive. They are physical assets that require maintenance. The income that they generate is based on geography, configuration, condition, the abilities of the property manager – the list goes on. Capital growth is influenced by geographic location and the specific neighbourhood – both of which can fall in and out of favour.

Current drivers of growth in property prices

Kitty Parker, a Sydney based Buyers Agent has been named Australian Buyers Agent of the Year in 2023. I recently spent some time asking her about her views of investing in property. She notes four current drivers of growth in property prices.

Migration. Government initiatives are promoting significant increases in migration. It is forecasted that this will impact demand for housing primarily in capital cities due to employment opportunities.
Rising construction costs and building company insolvencies. This has led to delays in the timing of new builds. It also has prevented people from being able to renovate or develop their homes to upsize. This restriction in developing supply has also contributed to demand.
A tight rental market with supply shortages and increases in rent. The ABC recently wrote about how rent costs more than a mortgage in an increasing number of Australian cities. Renters with deposit sized savings are now searching for properties to purchase.
Low stock levels. Less homes are coming onto the market. However, current investment property owners are using this as an opportunity to get rid of their lower quality stock. Parker calls out that it is important that inexperienced investors need to be aware of build quality and whether the investment credentials stack up.

The most common mistake with investment properties

Parker believes that the most common mistake that investors make when purchasing an investment property is bias towards their own preferences.

Purchasing somewhere that you may want to live may not always be the best financial decision. Many investors look at properties with the lens ‘would I live in this?’. If you’re living in a two-bedroom terrace house in Balmain in Sydney’s inner west, you’re not able to transplant that into a suburb in Adelaide and expect the same results.

These biases really come into play with interstate purchases.

A question that Parker has gotten from a client before is, ‘Do people actually seek out homes like that’?

These investments need to be viewed through the lens of financial performance and not preference. What we may like, or what we feel looks like a good place to live might be a substandard investment performer.

Property investment is strategic. It is about performance and not aesthetics. You do not have to live in it or like it. You may actively despise it, but it may double in value. It may deliver a 6.5% rental yield when your interest rate is only 3.5%.

To mitigate this bias impacting an investment property purchase, Kitty suggests three main tools to maximise success.

How to find success with investment properties

1. Understand the investment by using an investment property calculator. These are readily available online. It will help you to understand the property’s expenses vs. Probable income and the yield. Parker recommends doing this over a weekly, monthly, and annual basis to get a true picture.

2. A Depreciation schedule. This will give you the potential eligibility for depreciation in your tax which impact the overall return.

3. A Valuer. This is a service that will value the property. It is also a rigorous examination of what will add value to the property and what may be over capitalised. This is a tool to provide a professional understanding on how to add capital growth to the investment property in the most efficient way possible.

Positive or negative gearing?

Parker shares that successful clients will either involve a financial adviser or develop their own financial plan. It is only after they are clear on what they are looking for that they are able to search for an investment property that is best suited to their financial goals.
One of the main choices as an investor is whether you want a cashflow positive or negatively geared property. These are two distinct outcomes.

Positively geared properties are the ultimate goal for those that are looking for passive income. It may suit investors that are not on high income tax rates. Parker has found that this has been the route for many retirees that do not have high taxable incomes. It is also a route many lower income individuals take. She has served many single mothers that are looking for investment properties after a divorce and do not have surplus cashflow to service the mortgage and upfront costs.

Parker says that passive income isn’t the be all and end all for everyone. Negatively geared properties may suit investors that are on high income tax rates, have surplus cashflows to service a mortgage and expenses upfront, and are seeking capital appreciation. Success means finding a property that has high capital appreciation prospects.

There are a few markers of success that Kitty looks for with capital appreciation and positive cashflow properties.

Future growth drivers and markers of success

With future growth drivers, there are always hotspots that crowds will be drawn to. For first time property investors, ensure you are instead looking for a solid investment that mitigates risk.

Good markers of success are:

• Educational facilities nearby
• Medical and hospital facilities nearby
• Well serviced transport hubs OR even better – approved and funded projects that are forthcoming that will improve the transport infrastructure in the area. It is important that this is already funded, or construction has already started.

Where there’s interest

Parker mentions that the Perth property market is an area of interest for many potential buyers. The Perth market has recently experienced growth, attracting attention to the region.

She warns that this is a case study for property investors to step back and focus on the investment fundamentals. Perth’s property growth has been stagnant until recently. Property prices took a dive in 2008 and have not fully recovered since then. Investors have to be mindful of the drivers of growth in each area and whether it is suitable for a long-term, large investment of capital.

Source: Real Estate Institute of Western Australia

For capital growth, Parker sees a shift in investor preferences that will likely continue into the future. This has been particularly true after the Covid-induced lockdowns. Many investors and home buyers alike now prefer homes that are more open plan. These homes are conducive to socialising in living areas, including the kitchen. She also advises to look for outdoor space which includes a balcony or a backyard. This is a sticking point that many renters are not willing to compromise on. As many people have changed the way that they work, they are also looking for study rooms or nooks to accommodate some part of the week working from home.

Investors also love purchasing property close to home. Many investors looking for investment properties in areas that have experienced significant price appreciation may be letting their bias get in the way of better opportunities. The reason that is given to Parker is that many investors like to ‘drive by’ or be close to the bricks and mortar that they have staked substantial funds on.

This is particularly true for Sydney, which is Parker’s base. There are definite advantages to purchasing outside of metropolitan areas, and the top advantage is a reduced price point. She says that generally, properties within 2 hours of Sydney that tick the growth driver boxes should fare well over the next 7-10 years as we experience population growth.

Investing in property is like any investment decision. It pays to understand the result you are hoping to achieve and to put the work in to find the right opportunity.