Putting theory into practice in asset selection
One of the things that I think is really difficult for property investors is bringing the theory and then putting it into practice. We’ve always talked about the bigger picture of what we should be looking for in an asset selection. So you know, in terms of owner occupier appeal rather than investor only appeal. We’ve talked about it needing to be investment grade typically between $300,000 to $850,000, there are variations to that but that’s the typical investment grade sweet spot. And the third part is it got to have some form of scarcity which will help drive the underlying value. So that’s a really great framework to start but how does people overlay that to walking at street level and being able to apply it to the anxiety and adrenaline that comes from when they’ve got to put their name on a title and actually buy something. So I think there are four things that you need to consider and I think its best to illustrate it by talking about an example recently where I was looking to buy a property for a client that stacked up.
It has scarcity, had owner occupier appeal and it’s in an investment grade sweet spot so, tick, tick, tick! But then when I saw the property, I had to really drill down a little bit further.
And so, capital growth vise, I back-tested its performance and it actually stacked up which is really good. The second thing I need to think about is cash flow. At the end of the day, we need to afford the property and as a product of rental yield, I need to know how much income I’m going to get and how much is it going to cost me at the end of the bottom line. So again, it stacked up in those two things. The third thing is, if I’m buying a property that is investment grade, scarce and all those sort of things, I need to make sure I’ve got a tenant. And so, if I’m buying in a suburb with a really low vacancy rate that’s really good because I’ve got a really good chance of getting a tenant and it’s going to be in a really strong demand versus the alternative. But ultimately, I looked at this property, vacancy rate was low, capital growth performance was really great and there were no problems at all with cash flow. But I was having this niggle and the niggle was really all about one thing: the quality of tenant.
My view on what sort of tenant is going to end up in that property because it was a single fronted period home which most people love but down the road, there was a student accommodation there that is just being built. No one was in it yet but it wouldn’t be long before it was streaming with nightlife and studying, people coming in and out and all of those lifestyle that comes from being a student and their cycle of life. My view was simply this, I think that is going to affect the quality of the tenant because if some professionals were to look at this property and think this is really great but they look at that building and go, “Not sure this is where I am in my stage of life. I’m not sure this is for me because of that.” I think that would really severely impact the quality of tenant that I would like to give into this property and maybe if I couldn’t attract those tenants that I’m after, I might actually just get more students or someone who isn’t willing to look after the property well or happy to tolerate that. So ultimately, I’ve failed that test because the capital growth was fine, cash flow as a product of rental yield was fine, the vacancy in the area was no problem but that last one, the quality of tenant was something that I’m a little bit concerned about. That’s how I put these framework into practice when I’m out in the field.
So if anyone is thinking about those 4 things, they can get some help because a buyers agent will help you to stack up the capital growth potential. If you’ve got an investment savvy mortgage broker or even a financial planner who is helping you in your household’s cash flow management, they should be able to help you find out what that shortfall needs to look like. And the last two in terms of quality of tenant and the vacancy rate, a really good property manager is going to help you with that because they are going to know if they put a “For Lease” sign out at the front, that will probably be gone in 3 or 4 days versus 3 or 4 weeks. But they are also going to tell you, critically, what type of tenant is likely to live in that property all things considered. So they are going to be a really great source of intel for you. There you have it! When you’re in the field, looking to buy an investment property, you can overlay these investment criteria at the beginning but you are going to have to make a decision and hopefully those four things will help you make a better decision next time when you go and choose an investment property yourself.