How to choose an investment property

Many would-be investors get themselves all tied up in knots about when and where to buy an investment property and whether they can get a ‘great deal’.

But, it’s nigh on impossible to keep track of different property markets and types of properties, time your purchase at the right time in the cycle and get a bargain to boot. The most likely result of trying to ‘do it all’ is overwhelm, and consequently, not making any purchase at all.

So let’s simplify it a little.

What’s important when choosing an investment property?

A recent article by property investment guru Michael Yardney¹, stresses the importance of buying a quality asset above everything else. He says: “It is what you buy – not when you buy or what you pay – that matters most.”

In other words, in a quote reminiscent of Warren Buffett’s comment on buying companies: “It’s far better to buy a great property for a fair price than a fair property for a great price”. 

Why is a quality property so important?

As Yardney points out, the capital growth your property generates will impact your returns each and every year, whereas the price you pay is a one-off.

For argument’s sake, a high-quality, investment grade property tends to return an average annual capital growth of 6 to 10 per cent and above, whereas a lower grade property might show capital growth of between 1 and 4 per cent.

Even if you don’t get a ‘great deal’ on your purchase, if you pay a fair price or even slightly above market value, so long as you buy a quality high-growth asset, the price will only affect your investment return for one year. Once you start making high returns year after year, the small ‘loss’ you made at purchase will be long forgotten.

Conversely, if you buy a low growth asset for a bargain, while your return in the first year might be decent, over the long term you are still only going to get a low return. Worse still, paying too much for a low growth asset can be a financial disaster.

What is a quality property?

An investment grade property is a property that will always be in high demand but is only in finite supply.

To find the right property, Yardney suggests looking for the following:

1. A long and stable history of above average capital growth.

Look at past sales of the property as well as nearby properties that are directly comparable to it. The properties should have grown in value at a faster rate than the median for the city where it is located.

2. Building value that is less than 50 per cent of the property’s overall value

Land appreciates, buildings depreciate! High land value, compared to the value of the building on it, is essential in driving long term capital growth. You can usually find out the land value of a particular property from your State or Territory Service Department.

3. Scarcity

This includes:

• Scarcity of land – this means the location of the property should be highly desirable and not have any available vacant land for sale nearby.
• Scarcity of dwellings – the dwelling style must have wide appeal but be in low supply.

What if you find a bargain?

Occasionally, investment grade assets will come onto the market at a really great price. However, the reality is that being in the right place at the right time to buy it is going to be down to luck. It might happen – and if it does that’s great – but, according to Yardney, it’s certainly not worth wasting years of potential capital growth waiting for this unlikely event. He says investors who are continually trying to ‘buy well’ or ‘get a bargain’ tend to miss out on quality properties and the years of opportunity cost that comes with not being in the market.

Warren Buffett’s long time business partner, billionaire Charlie Munger, said of stocks (but Yardney says it applies to property as well):

“If a [stock/property] earns six per cent on capital over forty years and you hold it for that forty years, you’re not going to make much different than a six per cent return – even if you originally buy it at a huge discount. Conversely, if a [stock/property] earns eighteen per cent on capital over twenty or thirty years, even if you pay an expensive looking price, you’ll end up with one hell of a result.

SOURCES: ¹www.propertyupdate.com.au/it-is-what-you-buy-not-when-you-buy-or-what-you-pay-that-matters-most,