Investing in residential real estate is a popular way to grow your wealth and build a solid investment portfolio.
But get it wrong and it’s a surefire way to lose money and potentially even wind up in debt you can’t pay back.
To help make sure you end up on the right side of this equation, we asked a buyer’s agent and financial adviser about the most common mistakes they see property investors make.
1. Buying in the wrong location
Location, location, location.
It’s what we’re often told buying property is all about and it’s particularly true when it comes to investing, says Rodney McLoughlin, director at TBAS Buyers Agents.
That’s why he says getting the location wrong is the number one mistake he sees investors make.
“When the market is booming, prospective investors will buy anything for fear of missing out – a house on a main road, a front of building apartment close to noise, something not near transport or directly under a flight path,” McLoughlin says.
“These properties are easy to sell when a market is booming. But as soon as the market drops, they become much harder to sell. You can see a 20 per cent loss on them.”
The problem of location manifests itself in other ways too.
Premium, blue-chip areas with good infrastructure and amenities usually cost more. So, property investors on a budget often take their first step into the investment game by buying in less desirable or far flung locations.
“When the market is booming, prospective investors will buy anything for fear of missing out”
“We also see investors buy into newer development where there are lots of units, with not much infrastructure and a long commute to city with bad transport,” says McLoughlin.
“Or, spurred on by glossy marketing material they buy house and land packages, 40 km outside of Sydney, the Gold Coast or Brisbane.”
“They chase the high yield properties and ones that give tax depreciation returns, but after about 10 years they don’t get any capital growth.”
McLoughlin says in the worst cases, he’s even seen investors fail to get their deposit back due to a lack of price gains. And often this is not even offset by high yields. The reality is that properties in the middle of nowhere are harder to rent out too.
That said, McLoughlin acknowledges that some investors can’t afford negatively geared properties in blue chip areas within 10-15 km of a CBD and will need to go regional or choose a high yield property.
But, he says, buying in the best location you can afford should always be your number one consideration.
2. Ignoring the laws of supply and demand
If your investment budget allows you to buy several cheap properties instead of one more expensive property, wouldn’t you be better off taking that option to spread the risk and give yourself the chance of building a much bigger portfolio?
Not necessarily, according to Ben Sum, financial planner and mortgage broker with Wealthful.
He says you should always look to purchase the best property you can afford because it will appeal to higher income households who are willing to pay a premium.
He also says that over time these are the assets which are most likely to stay in demand.
“Valuations are come backing lower than the contract price – and in some cases, 10 -15% lower”
“When assessing whether a property would make a good investment, we believe you should always start by going back to the concept of supply and demand,” he argues. “It is scarcity which drives price.”
“Families and other buyers are willing to pay a premium for access to lifestyle benefits such as good school catchment areas, access to cafes and restaurants, and closer proximity to the CBD,” Sum says.
“As there is generally already a lack of supply of these properties, price will naturally be pushed up over time.”
3. Counting on capital growth when buying off the plan
There can be real benefits for property investors buying off the plan.
You can pay your deposit and not have to pay the remainder until completion. Plus, in a rising market you’re locking in today’s prices and banking on capital growth. So your property may be worth more by the time it’s built.
But in a falling market the opposite is true, and Sum says right now he’s seeing more and more off the plan purchases going wrong.
“We’re seeing cases where investors have purchased a property off the plan a few years ago and have been banking on the property increasing in value by completion,” he says.
“This means they’d be able to borrow to complete the purchase without needing to contribute any further amounts. But it is a really precarious position to be in.”
Because the property market has flattened or declined over the past year, so have the valuations of many off the plan properties.
“Valuations are come backing lower than the contract price – and in some cases, 10 to 15 per cent lower,” Sum says.
“This means that some investors have not been able to meet settlement because they have insufficient savings to make up for the shortfall.”
Sum also says that many investors are under the false impression that if they can’t meet settlement, they can forfeit their deposit and the developer can re-sell the property.
But what most investors don’t realise is that the developer can usually sue them for any shortfall if they can’t sell the property for the same price.
On top of this, Sum says that until the property is sold, the original buyer will be incurring default interest, generally at nine to 10 per cent a year, calculated daily. This can place yet more financial strain on an already stretched investor.
4. Being unprepared when flipping a property
Those reality TV shows where they make quick returns through renovating and flipping property make it look so quick and easy right? But real life can be very different to reality TV.
“We see a lot of buyers who don’t know how much it will cost to do a renovation,” says McLoughlin. “Or they inadvertently buy a house of horrors where you open it up and everything falls apart.”
McLoughlin says council costs can also add up and processes such as putting DAs into council can take a lot longer than investors think they will, scuppering plans of a quick flip.
Then there’s the perennial question of what happens if the market changes – will you even make a profit at all?
“We’re seeing this right now for high-end developments in Sydney. If the investor bought three years ago, prices will sometimes have come down by 10 to 20 per cent,” says McLoughlin.
Inexperienced developers can be left with heavy debt, rather than profit.
5. Not having a plan
Not having a clear investment plan can be a recipe for disaster, and often leads to an impulse buy instead of a considered, money-making investment decision.
McLoughlin says one of the most important things in guiding investors to the right property is to create a plan documenting their key goals.
“The first thing we do is establish their goals and how long they want to hold onto the property. Then we work out their budget.”
While some investors want to renovate and sell, McLoughlin says most investors he sees want to get a tenant in and hold onto it for at least 10 years.
Having a plan in place can keep you on track over this journey and help you get to where you want to be.
Many homeowners get lured into property investing by the idea of leveraging the equity in their home to buy another property. They plan to repeat this process again and again to build a portfolio that grows in value while they sleep.
Sounds great right?
It can work, says Sum, but you will need to invest in the right type of property. One of the common mistakes he sees investors making is overleveraging into poor assets.
“The main benefit of investing into property versus other asset classes is the leverage – you are able to borrow up to nine times your deposit to invest,” says Sum.
“newly built property can be riskier than established properties because they do not have a track record”
However, as he points out, leverage is a double-edged sword and borrowing to invest also magnifies the risk of losses. That’s why, he says, you need to be sure you’re making a good decision on which property to buy.
“Overleveraging into a poor asset could mean that you are stuck with an asset that isn’t appreciating in value – maybe even declining – but requiring you to pay interest. And the interest payments may increase if rates rise.”
In the worst cases, overleveraging can quite easily result in a financial spiral – and even bankruptcy.
7. Only looking at the tax benefits
Buying and leasing out residential property is known for being perhaps the most “tax friendly” way to invest and grow wealth, mainly thanks to the rules around negative gearing and capital gains tax.
However, these are likely to change if we see a change of Government in the 2019 election.
Regardless of any mooted reforms, Sum says that while tax is an important consideration, it should never be the main driver of your property investment decisions.
“Purchasing property with the chief intent to maximise your tax deductions is likely to result in investing mostly into newer builds for the depreciation benefits,” he says.
“[But] newly built property can be riskier than established properties because they do not have a track record, they demand a premium for being new, and the building flaws are harder to spot.”
“Also, negative gearing only makes sense if the growth potential of the property outweighs the yearly loss incurred, after accounting for tax benefits. But the growth potential of newer builds are typically not as great.”
What should you do if you’ve made a property investment mistake?
If you’ve invested in residential real estate and you’ve realised you’ve made a mistake, the first step is to get professional advice, says Sum.
If they recommend you sell, don’t hesitate, he says, even if it’s at a loss.
After all, successful investing is often knowing about when to cut your losses. Holding onto something that will continue to lose money is not in your interests.
McLoughlin agrees with that view.
“Ïf a property is losing money and not getting any capital growth, there’s no point holding onto it,” he says. “If you’re not getting a good yield and capital growth, you should cut your losses and sell.”
He says, at the same time, it’s important to understand that if a property has good fundamentals it will increase in value when the market turns and rises.
But some properties simply aren’t ever going to achieve much capital growth, especially if they’re in a low demand, low income or low growth area.
It all goes back to buying in the right location.