Three surefire ways to lose money in property

Author: Michael Yardney on 22 September 2010 Print
I was interested to read the Merrill Lynch Cap Gemini report which showed that about 15 new millionaires are being created in Australia each day, many on the back of their property holdings. However, at the same time a large number of property investors haven't achieved the success they wanted.

Now of course this isn't really surprising... this pattern of success is nothing new.

What does concern me more is a worrying trend where some investors are so keen to do something, in fact to do anything, that they are heading for property investment disaster.

I've come across many potential investors who feel they've missed out on the property boom that occurred over the last year or two and want to catch up.

Others feel that they are being priced out and are desperate to get a foothold in the rising property market. And there are those who find they are unable to obtain more finance and seem willing to try almost anything to participate in the current property boom.

To me, many of these potential investors they are heading down a path of certain property losses.

So today I'd like to share with you what I consider three surefire ways to lose money in property and one way to ensure you invest successfully.

What it boils down to is that in their bid to get into the property market, many investors are starting to speculate rather than invest. The problem is they are so determined to do something, so that they don't miss out. Even if they don't have enough money, or haven't developed the discipline to save, or they have already borrowed to their limit and the banks won't lend them more.

Of course, I understand why they are keen to share in the profits others have achieved through property, but sometimes the right thing for an investor to do is nothing.

I've made more money by the things I've said no to than the things I've said yes to. That's because all my investments have been made as part of a planned strategy that involves property, finance and tax.

But many beginning investors are now making emotional decisions and that's why I'm calling it speculation. Here are three surefire ways to lose money in the current property markets through speculation...

1. Off the plan purchases

Sure it sounds enticing... buy at today's price – settle or-on sell in a few years and you'll make a profit.

Yes it sound good, but does it work?

Currently one of the big issues with buying off the plan is finance. And I'm not talking about developers having difficulty getting finance, and therefore having to charge buyers above market prices to get their developments across the line.

I'm talking about the finance an investor needs to eventually complete his purchase. Since most loan approvals are only current for three months, obtaining a formal pre-approval for an off the plan purchase is impossible.

The problem is we currently have six big banks in Australia and they each have a policy restricting their exposure to not lending to more than 15% in any one building. This means that if there are 100 apartments in the building, and you're the 16th person to approach the bank, when the building is completed they may decline your loan application. But when you start running to the next bank, they've probably already filled their allocation also.

So some investors who buy off the plan will have to sell, because they can't get finance. Add to this the fact that there will also be some off the plan purchaser who never intended to settle on completion, but always intended to on-sell property when the building is complete and you have a whole lot of apartments up for sale when the building is finished.

Is this a problem?

Well it is if you have desperate vendors who lower their prices to sell at whatever the market offers.

And even if you are able to settle, the banks will only lend you a percentage of the new lower valuation on your property, which will be the lowest sale price achieved by one of the desperate vendors, rather than the price you contracted for.

Add to this the fact that banks often only lend on a 70% loan to value ratio in the postcodes where many of the big new developments are, and what looked like a good investment to start with starts to turn sour.

Of course, there are a lot of other reasons I would avoid off the plan purchases including the uncertainty of this type of project. There is uncertainty about completion dates, the level of finishes and the market conditions when you eventually take possession. All this means you need to buy your property at a significant discount to make up for these unknowns. But currently, developers have to sell their products to you at a premium, not a discount, to make the projects work financially for them so that they get development finance.

And if that isn't enough to turn you off buying off the plan, here's one last point. Almost all off the plan developments are sold to investors. On the other hand, we like buying properties in buildings that have a good proportion of owner-occupiers in them. We just find owner-occupiers tend to look after the buildings better, and enhance their long-term capital growth.

2. House and land packages

I know some investors buy house and land packages because they've heard that land appreciates in value and they feel they're getting a big block of land for their money. But when you think about it, usually the land accounts for less than half the selling price, giving these properties a very low land to asset ratio.

Others are considering buying in these new estates on the mistaken belief that as properties are cheaper there, they will be more affordable to the masses as property values keep rising. Of course, this is wrong because these are exactly the types of areas that suffer most when interest rates rise. Residents in these areas tend to have less disposable income than people who live in more affluent suburbs.

While they may be great places to live and bring up a family, in general new or outer suburbs are not good places to invest. Remember, one of the big factors that enhances capital growth is scarcity and that's something missing in these suburbs. Many properties look the same, and there's always another estate with more similar houses and more land just across the road.

Another reason I would avoid investing in these areas is their demographics, as they don't attract the same demand from a diversity of tenants as the inner and middle ring suburbs do.

Even worse, I'm now hearing of a number of promoters who suggest trading new house and land packages. In other words, they suggest buying house and land packages with the intention of on selling them once construction has been completed.

Boy is this a recipe for disaster!

Firstly, trading is not the way to become wealthy, accumulating assets is.

Secondly, there is no margin in house and land packages to allow for a trading profit. Price sensitive purchasers will go down the road and buy directly from the builder who can always sell properties cheaper than a middleman. And even if you could sell, and for a higher price than all the other speculators who are doing the same in the same estate, after stamp duty and tax, you'd lose out anyway.

And don't be fooled into thinking these are the areas that will outperform over the next few years. In the outer suburbs, people's wages tend to go up by the CPI. However, in the inner more affluent suburbs residents have more disposable income that increases by substantially more than the CPI. They often have businesses, shares, investments and they won't be as worried by rising interest rates.

3. Options

A third surefire way to lose money in property over the next few years is to follow some of the creating schemes currently being promoted by property spruikers.

People with little or no money are being tempted by the prospect of bypassing the steps of developing the discipline of saving. They are happy to hear the promoter's suggestion that you can control millions of dollars worth of property using none of your own money.

There's nothing new about these schemes. And if history repeats itself the promoters of today will become very rich while their students will learn a very expensive lesson.

Well if these methods don't work, what does?

There is one proven, time-tested method that has made average Australians very wealthy. However, it's nowhere near as sexy as some of the smoke and mirror techniques I have just mentioned.

If you want to grow your own significant property portfolio, you need to own properties that provide wealth-producing rates of returns. This means buying a property below its intrinsic value, in an area that outperforms the average over the long-term and one to which you can add value so you can create some capital growth. This could be through renovations, refurbishment or redevelopment.

That's what those multi-millionaire investors who made it into Merrill Lynch Cap Gemini wealth report did.

Michael Yardney is the director of Metropole Property Investment Strategists, a best-selling author and one of Australia's leading experts in wealth creation through property. For more information about Michael visit www.metropole.com.au and www.PropertyUpdate.com.au.