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How do we pick a good investment in a hot Sydney property market?

July 21, 2014

Sydney has enjoyed a solid 12 months of strong property growth. This growth cycle has been blamed on a number of factors, Overseas Chinese investing in the Sydney market, low interest rates, 1st Home Buyers with government grants and SD exemptions, growth in property investing via SMSF and an overall frenzy from people not wanting to miss out on the dream of owning a property rushing to get a piece of real estate, typically termed as ‘herd mentality’

This exceptional growth is not unusual, in fact those who can recall the 2007-2008 period, we had a comparable growth pattern with a good number of overseas buyers, investors and first home buyers. GFC and the subsequent events changed all of that in the following years and despite the challenges that followed, many good suburbs across the country still managed an average annual growth rate of 5% or higher.

Each time the property market rallies, we are left with an interesting debate among many of us who have missed out of an opportunity on when they should have bought. Lamenting on missed opportunities. If we go deeper into this observation, 12 – 18 months prior to a strong growth period, the arguments would have been a simple one, the property is overpriced and does not reflect the current prevailing market prices, especially when buying off the plan properties. Adding to this debate is the prediction after each significant growth cycle that the market is going to crash!!!!!

So you see a pattern here, procrastination, lack of decision making leads to a bigger problem, leading to a herd mentality, like purchasing decision in the peak of a market which leads significantly reduced rental yield ( if purchase is for investment) and lower than usual capital growth in the period immediately following the peak growth period.

So the question is when is a good time to buy? How do we pick the “right” time? What factors do we need to apply in addition to the market situation at that point in time to make the “right” decision?

When to invest?

The truth is that in my 20 years of investing, one can never routinely pick the right time to invest. The time to invest is NOW, whenever that will be. For a typical property investor, once they have the equity ready they can pretty much get into the market whenever they want. Let me qualify what I mean by this:

Strategy

Each investor needs to have a clear strategy on what they are hoping to achieve. For example, for a 40 year old person investing for retirement can be significantly different to a 55 year old person trying to do the same. Assuming both will retire at 65 years old. One has 25 years and the other has 10 years. Is tax minimisation via depreciation an important element? Or investing within SMSF for the tax benefits of within super more important? Or is there some other investment structure that needs to be considered?

Professional Expert

Is anyone helping you in your investment strategy? Accountants, Financial Planners, Real Estate Professionals, Conveyancing Lawyers, Mortgage Brokers/Lenders all have expertise and can help you in making good investment decisions, ensuring your investments are structured well, adequately geared to meet your taxation requirements as well as your overall cash flow requirements. Advice is most beneficial when the person giving you the advice does not have a direct benefit from the decision that you make or alternatively they fully declare the vested interest in the product you eventually purchase. Paying a professional fee for their advice and guidance is another way to ensure neutrality of the advisor in helping you make the decision. One thing we must all understand and respect is that we cannot expect free advice, when professionals take the time and effort to review your specific requirements and help/guide you in your decision making.

Geographic Location

Each investor has specific expectations for the investment. Typically they are looking at rental yield and capital growth expectation. At any point in time in Australia, there is a city or cities in this country that will meet the buyer’s rental yield and capital growth expectations. Do you buy in a city or a regional country town? Do you buy in a mining town or do you consider a tourism driven city? Or do you stick to major cities? Do you try to predict the next hot spot? How do you choose and how does each of these propositions drive your decision making process? Whatever it is, there will be a geographic location that will give the buyers the expected combination of rental yield and capital growth.

For example, Mr. Smith is looking at buying a 500K property and needs to have a minimum rental yield of 5.5% and an annual average capital growth of 5%. At 80% borrowing, this will most likely be a cash flow positive property. In the current Sydney market ( within a 20km radius of CBD) , this will be quite a difficult task to achieve, however this is not too difficult to achieve if we are to look at Newcastle, or Brisbane or event selected suburbs in Melbourne.

Property Type

In addition to a suitable geographic location, there are a number of property types an investor has to consider, such as houses, duplexes, townhouses, units, villas and apartments. One has to understand that each of these specific properties has its own rental yields and capital growth figures. The age old paradigm that a landed property will always deliver a bigger capital growth and/or rental yield is NOT always correct. One only has to pick a suburb and look at the last 10-20 years property price and rental evolution in that suburb for each of these different types of properties to understand that the age old paradigm is not always correct.

Property Class/Categories

Once we have had a good idea on the type of property, we have a number of options to choose from, a standard real estate product, a NRAS property, Defence Housing to name a few. Each of these delivers a different value proposition, different rental yield and perhaps with some argument a different capital growth opportunity. An investor also has to understand that in each of these cases, the cost of managing the property and the related strata, council, and water rates can vary considerably. This impacts the cash-flow of the investment, and understanding how the cash-flow impacts their decision making is a critical part of the decision making.

Established or Off The Plan Properties

Once the geographic location and type of property and the related options are selected, you then need to review the virtues of picking an established property or perhaps buying off the plan. A strong understanding of how each of these 2 options impacts your decision needs to be carefully reviewed and understood.

Builder and Developer Due Diligence

In the middle of all these decision making steps, an astute buyer should also review the profile of the developer and if the developer is not the builder, then the profile of the builder as well. How long have they been in business? What has been some of their past developments? How does their historical performance stack up? How do the buildings look?

Property Valuation

While this is not an issue usually with an existing property, buying off the plan carries valuation risk at the time of completion. Buyers need to understand how they could mitigate this risk, or how this risk could impact their finances at settlement if the valuation does not stack up to purchase price.

Cash Flow, Cash Flow, Cash Flow

A simple cash flow summary is always fundamental in the decision making process, rental revenue, property management cost, loan interest cost, strata, council and water rates as well as depreciation schedules and other related costs will help the buyer understand what the final cash flow could look like. How do the purchase impact your overall cash flow and your marginal tax rate are all important factors.

With so many developer/builders in a hot property market, it’s worth spending some time to review the profile and reputation of the builder/developer. This will ensure a peace of mind in terms of quality, reliability and overall performance of the product.

I have taken you through the topic of how to pick a property in a hot Sydney market and then regressed into the key areas for consideration in picking a good product in a hot property market. The truth of the matter is regardless of the fact you are in the peak, trough or anywhere in between of the property cycle all of these points are important and equally valid. I still hold the view that the time to purchase a property is NOW as soon as you are ready.

Das Nair is a Licensed Real Estate Agent in NSW and a partner in SUMO Global Properties, is a committed professional focussed on buyer education and learning and has been helping property investors understand the fundamentals that drives the property market, risks involved and how to capitalise on the opportunities, minimise risk and take a reasonably conservative, low risk and long term approach towards property investment and long term wealth creation. He is contactable via mobile on 0414 609 749 or via email on dasnair@sumoglobalwealth.com Sumo Global Properties do not provide any SMSF, financial planning and financial advice services.