How important is asset selection?
So I am always asked the question, “How important is Asset selection?” Because fundamentally, it is THE very thing that we are investing in as our vehicle of choice if we are property investors. Now I just wanted to show you that just getting a slight change in performance in asset selection can make an enormous difference. So have a look at this, in 1974, down in south, you have South Melbourne here and Cranbourne, which is now one of the further subdivision here in Melbourne. We can see that there was actually a reasonable prices differential where it’s actually more favourable at that point in time to move further out from the city and get your own patch of dirt and create your own Great Australian dream. So it’s actually more expensive to live in Cranbourne than it was to live in South Melbourne. Now fast forward to 2014, it paints a vastly different story. Because now, the medium price in South Melbourne is $1.19 million. Where else the medium price in Cranbourne is now $328,000. So as you can see in real terms, that is a significant different. What’s really important to look at is the difference in percentage terms, which can often be lost as to what that actually means in real terms, is 4%. So a 4% difference can have a massive difference on the impact of your overall wealth.
So for me, asset selection becomes fundamental and it becomes absolutely critical. Now in the past, all you really needed to do was put your name on a title and let time do the work for you. Because the conditions in Australia allow for the rising tide to lift all ships. I bought my first investment property in 1999 and I did a great job on trying to do everything I could to select it but at the end of the day, all I really needed to do was open the newspaper, close my eyes and whatever my finger landed on, that was the property that I should have bought. Because history has been very very good to property investors. But from this point moving forward, here we stand in 2016, we don’t believe that the rising tide will lift all shifts anymore because the conditions of interest rate. We are now at historical low, there is no way that we are going to get more injections or lowering of our cash flow from our expenses. And of course, we now got double income households. Generally, the opportunities have double income professional households. So, all of the organic growth in household income has now been exhausted. So moving forward, it’s all about getting the suburb right and then getting the asset right. So today, I want to talk about a framework that can help you to get the best chance and in some cases even 1 or 2% better than average outcome will have an enormous difference on your overall wealth.
So in the book, that Ben and I wrote, the Armchair Guide to property investing, we talked about this very framework that I want to talk about today. So I’ll embellish on that just a little bit. But what we want to talk about here is, what I find most property investors do is they start with the property first. So they go, “Well, I want to buy an investment property, this looks like a good one” and then they work backwards. I am going to suggest that that’s the wrong way around. What I think you should do is start with the location first, it’s absolutely critical. So really it’s starting from the State. So in Australia, we make up of a number of states and territories. Unfortunately, they don’t all move at exactly the same circle.
So the old saying of time in the market rather than timing the market actually holds true.
You should buy for the long term. But what I am suggesting is if you take a bit more of a smarter approach to that. If you actually get the timing right as well as obeying the principal of having time in the market, you can actually amplify your results. So by State, you want to be looking at which cycle is likely to be counter cyclical at this point in time, where you are going to get the best chance to getting some growth and next sort of 24 to 36 months. So you need to narrow down on what you need it to be. As I stand here in 2016, in most recent time, Sydney has done extraordinarily well, Melbourne’s done well, Brisbane started to have a little bit of a run but there’s a couple of other states that might be worthy of an opportunity to look at to see if there is a counter cyclical opportunity. So again, that borderless investing approach that we always talk about here at Empower Wealth. So number one, you need to get the state and then region within the state right. If you get that right then you get the next chance of the growth.
The next step is to identify the suburb that you want to be buying at. Now, not all suburbs are investments grade because all suburbs provide shelter but not all suburbs provide shelter AND are investment grade. So it is important to understand what makes for an investment grade suburb so you give yourself the best chance of getting capital growth. Now keep in mind that the rising tide will not lift all ships anymore so it’s not good enough to just put your name on the title and wait for time to do the work. You may be disappointed moving forward. So if we get the state right, you then narrow it down to which one is investment grade suburb. And that’s largely around determining the demographics of the people in those suburbs who are likely to be control of their income. Because what we know is the bank is always going to determine whether you can borrow money which is determined by the amount of income that you earn. So if you are buying in the suburb where the demographic is only getting CPI increase on their income, chances are, you are going to hit glass ceiling on price. No matter how much people want to spend more on property, if they can’t get the bank to lend them the money they won’t be able to do it. Versus someone who is in the role where they might get a $20,000 pay rise or they are in sale or small business or medium business or someone who has the opportunity to be in control of their pay increase each year. They then have more borrowing capacity which means that they are more likely to pay more for assets. And you as the investor can get suck along for the ride within those suburbs. So it’s really critical that you get that right.
And you know yourself in the suburb that you live in, there are A grade streets, B grade streets and C grade streets. So typically, we’re looking for the As and the Bs and we really want to avoid the Cs. That’s really about getting started from the macro and start to drill down on the particular properties but if we can get into the streets where we know the higher income earners prefer to be. Whether it’s the tree lined streets, walking distance to the train, the cafe is up the road or there is a beautiful park where you can spend your leisure time. All of those lifestyle drivers that make a certain part of the suburb more attractive will also give you an opportunity to outperform. As you saw in the previous slide, it makes for an enormous difference.
Then we get down to property and that is where most people started but you can see that there are three more important parts prior. Now, I am not suggesting that houses are better than town houses that are better than apartments. I’m an investor myself and as a professional advisor, I’ve helped people buy all of those categories. But what I am saying is, it’s really critical that you know which one you should buy.
So if you are buying an apartment, don’t get caught up in the big off the plan, high rise apartments because for me, I prefer the old 1970 style flat with no pool, no caretaker and no lift.
Where they are in better location, surrounded by beautiful homes where those owner occupiers will continue to drive the price and I’ll just get suck along for the ride. So, property selection is really about understanding what’s important for that particular demographic and what’s important for that area. But make no mistake, I have got a strong preference for established property over brand new aparments and I’ve done plenty of videos about that prior.
Now, the next step is to really get down to the due diligence. I can’t say due diligence, can you tell? The DD when you are looking to buy a property. What I am suggesting here is unpack a little bit and have a look behind the facade because at face value, some properties can look the same but it is not until you do your DD, until you understand that there are several differences that have an impact on investing. So using the apartment as an example, I remember buying a property for a client on the show, Location Location Location Australia and it was an art deco apartment. At face value, it looks like any other art deco apartment but the title through our DD process, was actually a company title. For anyone who knows how a company title work versus a strata title, you are actually not buying a real property with a company title. You are actually buying shares. So if you are buying apartment number 2 for example, typically, you might be buying share number 200 to 299. That actually has ramifications with the bank and with lending. So given that property investing is a game of finance, more so than a game of bricks and mortar, if we know that there is going to be ramifications with that particular type of title, it’s important for us to know what impact that will have on the portfolio down the track. So we will only understand that by doing our DD to find out all of these intricacies with the particular property.
So you can start to see a part of our framework that we are building here. We start from the state, we drill down to the suburb, we go down to street level, we are really specific about the type of property that we’re looking for. Then, we go down even further into the detail with the DD, employing professionals like a solicitor who can help us better understand the contract. And then last part of that is we go into the negotiation. Now unless you negotiate all day, every day, as part of your job, chances are you are going to be up against it when you are dealing with a real estate agent. Because good real estate agents are good negotiators. They are trained to see both verbal and non-verbal communication signs that you give them. Their goal is to get the best outcome they possibly can for their client, which is the seller of the property. They have got no loyalty to the buyer whatsoever. So it’s important that you understand your negotiation strategy and your skills. And if you don’t have any strength in that particular area, consider whether or not you would get a friend or a trusted professional who actually does have negotiation skills, who can actually help you do that.
So as you can see, there is a fair bit in it. It’s not just about opening the newspaper, opening the magazine, trolling the internet portals, to see which property we should buy. There’s actually a science and a process involved in an asset selection. As you can see from the previous slide, it makes an enormous difference getting these stuff right. So I hope that helps with you and we have gone a bit more detailed in the book on that asset selection framework and that asset selection process. I hope that helps you, next time you look to buy another investment property for your portfolio.