A Straightforward Guide to Property Investment Strategies
There is no doubt in my mind that property investors are a unique breed. Investors in many other types of asset classes (like shares, managed funds, indirect property, deposits, super etc..) play a relatively passive role in the investment decision making process. The majority of these type of investors allow their advisors (fund managers etc..) to take the drivers seat and make their decisions for them.
However, direct property investors have chosen a real niche to conduct their business. The niche is usually too deep for general advice and given the nature of property they need to be more “active” and treat their investing as a business rather than a passive investment. The investor themselves is fully responsible for their success & failure, not a fund manager or share broker. The property investor is fairly and squarely in the driver’s seat.
It is a difficult role to play and an even more difficult role to do exceedingly well. I believe there are 3 different types of systems a property investor needs to master to be effective:
1. Property Systems
2. Money Systems – your capital, cash flow and finance plan
3. People Systems – your team and self management
In this article I will deal only with the first system. Property Systems.
In my opinion there are generally two different types of residential property investment strategies;
- Passive (or defensive) strategies and
- Active (or offensive) strategies.
Passive (defensive) strategies are ones where the investor puts in a standard amount of effort and therefore the investment has a standard risk profile and standard return. They also typically require a normal deposit (3%-20%) and normal finance (97%-80%), they receive natural capital growth (3%-10%pa) and a natural yield (2.5%-8%). These types of strategies include:
- Cash Flow vs Growth
- Houses vs Apartments
- New vs Old
- High price vs low price
- Off-the-plan
- Special purpose
Active (offensive) strategies are ones whereby the investor puts in more effort on a more “creative” type of opportunity which therefore typically has a higher risk profile and return. These strategies usually involve a creative deposit (<3%) and a creative finance solution (>97%). The rewards for this extra effort are instant capital growth (5%-25%) and higher yield (>8%). These type of strategies include:
- Renovation
- Development
- Unconventional
Cash Flow vs Growth Strategy
Cash Flow properties:
These are properties with a low capital growth profile of 4-6% and high rental yield (return) profile of around 6-10%. Occasionally though the capital growth can be very high for a short while.
Advantages:
- Positive or neutral cash flow;
- Use surplus cash flow to pay down principal to get more equity for future investment;
- Small entry price – easy to get started;
- Lower stamp duty & land tax;
- Occasionally good equity jump due to demand for high yield properties;
- You can’t lose having money in your pocket (unless you get in too late);
- Easier to get a full-doc loan;
Disadvantages:
- Pay tax along the way, money in the tax man’s pocket is not going to create wealth for you;
- Slower capital growth over longer term;
- Usually regional or outer areas which can be quite sensitive to economic cycles;
- Harder to get low-doc or no-doc loans for some regional properties due to postcode & population;
- Lower leverage to reduce return;
- Potential higher maintenance of property and more tenancy problems due to social economics;
Growth properties:
These are properties with a higher capital growth profile of 7-10% (and occasionally over 12% for a short while) and a lower rental yield (return) profile of 3-5% rent (occasionally below 2.5%).
Advantages:
- Tax benefit: negative gearing and delayed CGT;
- Usually consistent capital growth over longer term;
- Usually inner areas and high population areas which are not affected as much by economic cycles and interest rate;
- Easier to get a low-doc or no-doc loans;
- High leverage available;
- Potential lower maintenance of property and less tenancy problems due to better social economics;
- Equity increase can be available to invest further;
Disadvantages:
- Negative cash flow if you take on a normal mortgage at high leverage level;
- Usually more expensive than cash flow properties – higher barrier to entry for beginners;
- Higher stamp duty & land tax;
- There is no guarantee for capital growth every year – you may bet on the wrong horse;
- Harder to get a full-doc loan to access cheaper interest rate mortgage while your portfolio gets bigger;
Houses vs Apartments Strategy
Houses
Advantages:
- More consistent growth over long term in established areas;
- You usually own the land;
- You have greater control over what you want to do with it;
- High land content for better future growth if it is in established areas;
- Usually easier to get finance;
- More room for value adding and modification;
- Town houses are getting popular with smaller family size and retirees;
Disadvantage:
- Usually lower rent as a percentage of the value;
- Can be higher maintenance;
- Big houses sometimes can be hard to get good rent;
- Less security and facility;
Apartments
Advantage:
- Higher rental as a percentage to price;
- Less hands on maintenance;
- Good growth in fully built up areas with height limit;
- Start to become trendy with younger generation;
- Meeting the trend of smaller family size;
Disadvantage:
- Less consistent growth in areas that are not fully built up;
- Body corporate fees;
- Less control;
- Less room for value adding;
- Can be hard to get good finance for company title properties and very small apartments;
New vs Old Properties Strategy
New Properties
Advantage:
- Higher tax benefit;
- No maintenance;
- Better appeal to tenants due to new design and technology, etc;
- Easy to rent if the asking rent is not too high;
Disadvantage:
- Lower capital growth in comparison to established properties in the same area for a few years;
- Higher purchase price due to premium for being new;
- Usually get hit first if the market is slow;
- Very little room to add value;
- Price set by developers may be artificial or heavily influenced by organized marketing effort;
Old Properties
Advantage:
- Purchase price usually set by individual vendor without commercial manipulation;
- More solid growth than new due to heavier ‘land content’ component;
- Less price fluctuation than new properties in the same area;
- Potential to add value;
Disadvantage:
- Higher maintenance;
- Not as appealing to tenants;
- Future requirement for renovation;
- Lower than usual rent if the property is too run down;
High vs Low Price Property Strategy
High Price Properties
Advantage:
- Less number of properties to deal with;
- Less ongoing soft cost such as bookkeeping, etc;
- Less work looking for them;
- Usually in expensive suburbs that have solid growth performance;
- Better quality tenants;
Disadvantage:
- Luxury items get hit first during bad times;
- High price properties in low price suburbs may have slower growth due to lack of demand;
- Harder to get finance – lower leverage;
- Higher stamp duty and land tax;
Low Price Properties
Advantage:
- More stable performance near median price of the suburbs;
- Lower price properties in established suburbs can handle down turn better;
- Better diversification for rent and resell;
- Lower stamp duty and land tax;
Disadvantage:
- More work finding them;
- More ongoing soft cost such as legal and accounting expenses;
- Not as appealing to tenants;
- Lower than usual rent if the property is too run down;
Off-The-Plan Strategy
Advantage:
- Potential gain before settlement if you get it right;
- Saving of stamp duty;
- Available to overseas investors;
- Little money down through bank guarantee, deposit bond or builder’s terms;
Disadvantage:
- Potential loss of deposit plus gap if you get it wrong;
- Buying site unseen;
- Purchase price can be set artificially;
- Purchaser can be influenced heavily by organized marketing effort;
- Area and products may not be tested – performance unknown;
Special Purpose Property Strategy
Serviced Apartments
Advantage:
- Hassle free;
- Usually higher rental if managed properly;
- No need to worry about tenants and maintenance yourself;
- Desperate sellers;
Disadvantage:
- Harder to get finance due to commercial contract;
- Can be hard to resell;
- Growth is tied into yield and how well it is operated, not necessarily reflecting local property prices;
- Value of the property is affected by the financial viability of the operator;
Display Home
Advantage:
- Usually built to above standard quality;
- Higher rent guaranteed for the contracted period;
- No need to look for tenants or do any maintenance;
Disadvantage:
- Can be over priced in compensation for the guaranteed rent;
- Can be hard to get finance from some lenders due to valuation and commercial arrangement;
- Display operator’s financial viability can affect the rent they guaranteed;
- Property usually in outer areas with slower long term capital growth;
Student Accommodation (Managed)
Advantage:
- Higher rental if managed properly;
- No need to worry about tenants and maintenance yourself;
- Affordable purchase price;
Disadvantage:
- Can be hard to resell sometimes due to its special purpose;
- Growth is tied into yield and how well it is operated, not necessarily reflecting local prices;
- The value of the property is affected by the financial viability of the operator;
Renovation Strategy
Advantage:
- Instant increase of equity for further investment or better risk management;
- Most money pay to the ‘land component’ to ensure solid future growth;
- Instant increase of rent for better cash flow;
- More efficient use of funds;
- Great tax benefit;
- Lower town planning and building risk;
- You can buy under market value sometimes;
Disadvantage:
- Lot of work if you do it yourself, lot of management if done by others;
- It takes time to find the property that can make the numbers work;
- Easily underestimate the time, cost and work involved in a renovation;
- The increase of equity and rent sometimes may not be obvious enough to justify the cost and effort;
Development Strategy
Advantage:
- Excitement and pride - you can call yourself a developer!
- Potential good profit above cost;
- You create the equity instead of waiting for it;
- Potential to get finance and capital based on the deal instead of your own capacity;
- Allow a lot of creativity to create value;
- Multiple exit strategies to make money;
Disadvantage:
- Not efficient use of your money due to long processing time;
- Easier to make a loss if you don’t know your craft;
- Planning risk, building risk, finance risk and selling risk;
- Require larger capital base (than estimated usually);
- Require lots of commercial and people skills;
- Lower income while holding the site for permit;
Unconventional Strategies - Wraps, LPO, Rent to Buy, Vendors Term, JV, options
Advantage:
- Very little or no money down;
- Positive cash flow;
- Instant equity on entry and/or exit;
- Can combine other property strategies;
Disadvantage:
- You have to think hard and work hard;
- You have to spend more time learning;
- You need to be very entrepreneurial;
- Difficulty in managing investor, vendor, real estate agent and tenant/purchaser;
- Extra legal and accounting expenses;
So there you go. Fifteen different strategies for you to consider. Each with their unique characteristics and none better than any other. Investors make good money out of all of these strategies.
But which one suits you? Are you better off with a Passive (Defensive) or Active (Offensive) strategy?
I think the best piece of advice I can give any investor is that….there is room for both;
Firstly, you always need to have a defensive strategy in place. A defensive strategy will ensure that you get more predictable results – you are guaranteed not to lose. If you incorporate this type of strategy into your property system you will ensure that you are less emotional and more consistent. It also means you will always be making good use of your TIME. Which has to be a major consideration for any investor.
Secondly, you should use offensive strategies at the right time. If you start with nothing or very little, you can start with more offensive strategies to build your equity, and be good at one thing first. My advice would be to focus on one strategy initially and become very good at it. This is your best bet to make serious money before become too diversified and defensive.
Be careful though. When considering adopting an offensive strategy to take advantage of a great opportunity, the time to do it is only when you are sure it will not affect your overall stability. And when your time comes, don’t hesitate to speak to your Investors Direct Finance Strategist for some practical advice before taking the plunge!
This article was written by Bill Zheng, founder of Investors DirectTM Financial Group, a leading property finance company that provides finance solutions exclusively for property investors and developers. He has been a keynote speaker for numerous high profile property and finance conferences throughout Australia and overseas.
Copyright © 2007 Investors DirectTM Financial Group.
Bill Zheng
Investors Direct
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