- A successful investment property should be chosen on the basis of capital growth potential
- All other reasons for investing, such as depreciation and tax, should be side benefits
- The number one consideration in identifying a good investment property location, location, location
- There are a number of other must-haves that mark an 'investment grade' property
Some property analysts say less than 5% of Australia's 2.2 million investment properties are what they term 'investment grade'.
This essentially means they consistently deliver strong capital growth - or roughly double in value every seven to 12 years.
But different property investors can have different goals. No matter what strategy you have in mind, a good investment property should come with some must-haves.
Looking for an investment property: what to consider
1. Location, location, location
Location does "80% of the work", according to property investment expert and former co-host of television show Location, Location, Location Bryce Holdaway (pictured below).
“Most of the time, I find people talking about the property first and the location second. I would actually say that you need to really focus in on the investment-grade location because it will do most of the heavy lifting.
Some first-time property investors think they have to buy a house at all costs, which means they might be 50, 60, 70 km out. Whereas if they decided to buy a townhouse closer into one of the big built-up areas, they might get a better outcome.
An average house in a great location will do better than a great house in an average location.”
Bryce Holdaway
2. Close to everything
In terms of what makes a location great, most of the experts we asked agree that being close to either:
- the CBD, or
- the beach
is key, as is close proximity to lifestyle amenities like cafes, shops, restaurants, parks, good schools, and public transport.
Property market academic Peter Koulizos said location is a golden rule of real estate and matters because, unlike the home itself, location is permanent.
“You should pick an A-grade property in an A-grade location, however, if you can only afford one of these factors, ensure you pick the right location. You can change the property but you can’t change the location."
Peter Koulizos
3. Supply vs demand
Buyers are often advised to look for areas where demand is high and the supply of new stock is limited.
Investors should also look at the vacancy rates of the suburbs they are targeting, according to property investment adviser Niro Thambipillay from Investment Rise.
“An investor needs to ensure they can get their property rented first and foremost.
Too many investors buy in an area without considering whether it can be easily rented or not and this can cost them from a cash flow and lifestyle perspective.”
Niro Thambipillay
Generally, the lower the vacancy rate, the better for investors as it can be an early indicator of the potential for future capital growth.
Conversely, a high vacancy rate can be an indication of oversupply, such as when dozens of new high rise apartments are being built in an area. High vacancy rates can mean investors may struggle to get their property rented because they will be competing for the same pool of tenants.
The industry standard of a market imbalance is a vacancy rate of around 3%, so investors should aim for suburbs with a lower vacancy rate than that.
4. Potential for capital growth
After identifying a great location, investors are advised to target properties that have good potential for capital growth. The two must go hand in hand.
Capital growth refers to how the property appreciates in value over time, a key way investors build wealth and particularly crucial in an investment property.
Buyers agent and former co-host of Location, Location, Location Veronica Morgan said one of the biggest mistakes first time investors make is not prioritising capital growth.
“Too many investors focus on things like depreciation, saving tax, rental yield but what they really need to be looking at is capital growth and types of properties and areas that are likely to give you good capital growth because, without that, they’re taking on way too much risk with too little gain."
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Veronica Morgan
It's a sentiment echoed by Metropole property investment specialist Michael Yardney who said investors should seek areas with a long history of strong capital growth that will continue to outperform the averages.
"Many beginning investors are looking for cash flow, but they need to build an asset base first. Then they can 'buy' cash flow.
Capital growth is the most important factor of all in the performance of your investment property, even though cash flow is the ultimate end goal. But you can only turn to cash flow once you've built a sufficiently large asset base of 'investment grade' properties."
Michael Yardney
Mr Yardney also says investors may wish to look for properties where they can create capital growth through renovations or redevelopment.
5. An element of scarcity
There are many reasons property experts say off-the-plan apartments usually make terrible investments, one of them being that high-rise and medium-density accommodation often has little to no scarcity value.
Just because high-rise developments are designed for the investor market, it doesn’t make them investment grade, according to Mr Yardney.
“They are what the property marketers and developers sell in bulk to naive investors – usually off the plan, but they are not investment-grade because generally they have little owner-occupier appeal, they lack scarcity, they are usually bought at a premium and there is no opportunity to add value."
6. Unique or special
Mr Yardney said investors should aim for properties that offer something scarce, unique or special, such as an older-style apartment built between the 1920s and 1970s because their architectural style tends to be scarce and timeless and they’re often located in areas where land is rare and in demand.
Art deco, character, or period properties can generally make good investments too as demand for these types of properties will always outweigh supply.
7. High land-to-asset ratio
Mr Yardney said a high land to asset ratio doesn’t necessarily mean a big block of land, but one where the land component makes up a significant chunk of the asset value.
“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."
Founder and managing director of Property Planning Australia David Johnston said knowing the land-to-asset ratio of a property is essential as land value typically appreciates which drives price growth, whereas a dwelling usually depreciates in value. Because of this, it can pay to have a significant percentage of the property value made up of land value.
“From an investment perspective, you should strive to select an asset where the land represents 70 per cent of the value of the property, with 50 per cent as the minimum.
You can have a high land-to-asset ratio due to a large land size, an older dwelling, or a high land value per square metre.
Of these factors, it’s best to focus on the latter, as it is more likely to occur in highly sought-after locations.”
David Johnston
Mr Johnston said highly sought-after locations, typically close to CBDs, are generally more established and tend to have a higher proportion of older or character style homes.
“These properties are more likely to have a better land-to-asset ratio than recently built properties that are yet to complete their depreciation phase,” he said.
8. Maximum appeal to owner-occupiers
Just over two-thirds of Australians are owner occupiers of their homes while the remainder are renters, according to Australian Bureau of Statistics (ABS) data.
With that in mind, owner-occupier appeal should be a key consideration because owner-occupiers make up the largest segment of the market when you are ready to sell the property down the track.
Ms Morgan said investors should target properties that will appeal to a wide range of owner-occupiers.
“We encourage our investor clients to think like owner-occupiers, as owner-occupier appeal is really what is one of the foundations of capital growth,” she said.
That’s because owner-occupiers tend to buy with their heart, not their head, when buying a property which can drive the prices they pay higher.
“One of the big mistakes investors make is that they’re buying ‘investment stock’ and they’re not thinking about the wider market. There’s no secondary market for that sort of stock unless it actually appeals to owner-occupiers.
Ultimately, it’s owner-occupiers that push prices up and there will be some investors in the mix as well. But you want more than one type of buyer that’s interested in a property down the track when you want to sell it.”
Besides being in a good location, qualities owner-occupiers look for in a property are:
- street appeal
- lots of natural light
- openness
- a connection between indoors and outdoors
- good ventilation
- abundant storage
- a good floor plan
Choosing your first investment property
The first property you buy can make or break your fate as a property investor, so it’s important to get the foundations right, according to Ms Morgan.
If your foundation is not strong and solid when it comes to building a property portfolio, you will never get a number two.”
There’s a reason that over 70% of Australian residential property investors only ever hold one investment property and don’t ever get to the second.”
A, B and C-grade properties: Why the grade matters
How are properties graded
The real estate industry routinely classifies properties according to their location, qualities, and investment potential.
A Grade
“An A-grade asset is something that lots of other people want. There’s scarcity,” Ms Morgan said.
“It also has certain characteristics that make it appeal to more buyers than others. For instance, in a family-oriented area, you want a property that's going to have maximum appeal to families. So a three-bedroom home is not going to be as appealing as a four-bedroom home.
An A-grade property is going to have all the qualities that the most people will go for. And when there's a lot of property on the market, you want yours to stand out as being the ‘I want that I'm not going to compromise' one."
B Grade
B-grade properties are generally in the right suburb, but not necessarily where buyers prefer to be. They may be further away from amenities, lack parking, or have an awkward floor plan.
“A B-grade property could be on a really good street, but the property itself doesn’t necessarily have a lot of emotional appeal but is well located,” Mr Holdaway said.
C Grade
Properties with a C-grading may be located on a main road or on steep or battle-axe block, and have little appeal.
“C-grade property is actually more of a cookie-cutter approach property, so there's nothing unique about it,” he said.
How does it translate?
Ms Morgan said the grade matters because it affects how an investment property performs.
“An A-grade property will go up at more than the median house price and if the market goes down, it's going to go down less than the median. So it will always perform better than the median.
There's a lot of sayings that go around with property. One is ‘a rising tide lifts all ships’. Well, that's crap. Any given suburb, any given types of property, you get some that perform better than others. So, they're not rising or dropping at the same rate.
Another saying is ‘safe as houses’. Well, that's actually crap too, because there's plenty of people who lose money in property. And it happens way more than people want to talk about.”
Capital growth versus rental yield
Almost all the experts we spoke to unanimously agreed that rental yields are not a reliable indicator of a good investment property.
"You need to be able to afford to hold property and the problem with an A-grade asset is they are typically harder to buy, the market for them is more competitive, you have to spend more money buying the property in the first place, and often the yields are very low on an A-grade property. So, it’s sort of counter-intuitive to what you would expect.
The problem with that is that a lot of people go the safe route. They borrow less money and they go for where they get more rent because that makes them feel better that they can pay a mortgage off, but the problem is you’re just buying the right to collect rent, you’re not actually buying an asset that’s going to grow in value.
Yield and growth tend to be mutually exclusive. The higher the yield, the higher the risk, and the less potential for capital growth.”
Capital growth vs cash flow
Mr Holdaway said while rental yields are not a good measure of a superior investment property, they do help with cash flow.
“Capital growth is what you’re chasing, but the rental yield is what you’re actually wanting ultimately because you want to live off the passive income that comes from having the rent from these properties.
I think you should chase capital growth in the early part of your investing accumulation cycle. And then towards the end, you want to be able to retire out the debt so that you can live off the rents, but in some cases, people who don't have a lot of equity really rely on that rent return early.”
Beware the cash flow trap
Mr Yardney said in Australia, residential real estate is generally a high growth, relatively low yield investment.
“Those who try to invest for cash flow never develop the financial freedom they’re looking for.
You can’t save your way to wealth, so it is very clear that capital growth should be the main aim of property investors and not cash flow, at least not in the short-term until they have built a sufficiently large asset base.
Unfortunately, that’s just how property in Australia works – it’s not a cash cow. Sure cash flow is important to keep you in the game, but it’s capital growth that gets you out of the rat race.”
Why are you buying an investment property?
If you haven't cottoned on by now, according to the experts, there should only be one motivation to buy an investment property - capital growth.
All other considerations should be merely side benefits.
Depreciation
Mr Holdaway said too many first time investors get lured in to buying an investment property - particularly off the plan apartments - because of the depreciation.
“They get seduced by bling, which means they get sold by some slick salesperson saying they should buy properties for depreciation and for tax benefits.
But I say that's actually just a bonus. It's the cream. It's not the reason that you buy - you should actually be buying for the growth potential first before you worry about a tax outcome.
“I wouldn't buy off the plan just to get depreciation. I'd want the investment to stack up first and then make sure I get the most depreciation that I possibly can after making that decision first.”
Tax benefits
Investors should avoid buying an investment property (particularly off the plan) purely for tax reasons, Ms Morgan said.
“It’s a massive red herring.
With depreciation, you’ve got to spend a dollar to get back a maximum 45 cents or whatever the top tax rate is now. I mean, it’s just simple maths. It doesn’t make sense.
If you’re not buying with capital growth as a primary motivator, then why lose 53 cents in every dollar that you spend?
Finding the right home loan
Another important consideration of successful property investing is finding the best home loans to fund your investment activities.
Not only should you aim for a low interest rate, you should look for the features that are going to best suit your individual circumstances and investment strategy.
The table below is a good place to start.
Lender Home Loan Interest Rate Comparison Rate* Monthly Repayment Repayment type Rate Type Offset Redraw Ongoing Fees Upfront Fees Max LVR Lump Sum Repayment Extra Repayments Split Loan Option Tags Features Link Compare Promoted Product Disclosure
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