Know which properties to avoid

At any given time there could be over 350,000 properties for sale in Australia, but in my mind less than 5% are what I would call “investment grade”.

So let’s look at what type of property a property investor should not buy.

Firstly let’s explore…

Properties the banks don’t like

There are certain properties that the banks don’t seem to like and against which they will lend a lower loan-to-value ratio, meaning you’ll need to fork out a bigger deposit.

More importantly, if the banks are wary of them, rather than thinking you know better, take it as a warning sign and consider looking elsewhere.

In general, the banks restrict lending to properties that appeal to a limited resale or tenant market including…

1. Serviced apartments – These carry a lot more risk than buying an ordinary apartment as you’re relying on the operator to get it right and on the tourism and business markets to remain strong to maintain occupancy.

These properties have a limited resale market (since only investors buy them you’re cutting out up to 70% of potential purchasers), a limited letting market and often have expensive ongoing management costs.

2. Department of Defence housing accommodation – While these properties come with the certainty of long leases and no ongoing maintenance, they have a limited resale market and hefty management charges.

3. Small units – Most banks prefer apartments to comprise at least 50 square metres of living space, not including balconies or car parking. However, with our changing lifestyles some will now lend on properties that are 40 square metres in size.

4. Studio apartments and student accommodation – These also have restricted markets because of their size.

5. Large off-the-plan developments – Banks worry about a “concentration risk” and therefore restrict how many apartments they will lend on in some large new complexes.

Of course there are lots of other potential issues with off-the-plan properties that would make me wary of this type of investment.

Other properties I would avoid

1. Out of place – I only buy properties that fit in with the overall character of their neighbourhood. While I love terrace houses, if the property happens to be the only terrace in a street full of bungalows, I’d look elsewhere and buy a property consistent with the streetscape.

2. The wrong location in the street – Even the best streets can have sections with an unattractive mix of properties or that are too close to the shops or main road. Choose livable streets and make sure you buy the right property in the right section of the street.

3. Encumbrances on title – Check the title carefully for easements, covenants or overlays that could restrict your capacity for future extensions or rebuilding.

4. Other title troubles – Banks will restrict their lending for apartments on some older forms of title, such as company-share or stratum titles.

5. Body corporation problems – When buying an apartment carefully peruse the minutes of the last few owners’ corporate meetings. Are there any issues with the building or excessive expenses planned? Has a sinking fund been set up to handle future repairs or refurbishment?

6. No car parking– While absence of parking may save you some money today, it will always limit an apartment’s appeal to tenants, homeowners and future investors.

7. Wrong position in the block – Avoid apartments in sub-optimal positions in the block. You know what I mean… the ones overlooking the car park or situated near the waste bins.

8. Avoid main roads and secondary locations – Sure people live everywhere but when the market slows secondary properties are harder to sell and fall in value first.

9. Rental guaranteed apartments – Remember the cost of the rental guarantee (which is usually inflated to make the return look better than it really is) is added to the purchase price and used by the developer to justify inflated prices.

In other words, you’re paying the developer up front to guarantee the rent for you. And it’s not uncommon for the rent to drop when the rental guarantee period expires, leaving you with a hole in your budget.

10. Holiday homes or apartments – I’m not suggesting don’t buy yourself a weekend getaway property if you can afford it. What I’m saying is don’t pretend you’re buying it as an investment, because you’re likely to end up with an asset that on the one hand isn’t meeting your lifestyle dreams and on the other, doesn’t deliver your financial objectives.

11. Mining towns – These markets tend to have little market depth from owner-occupiers and, being more investor-driven, tend to be more volatile and best avoided.

12. NRAS (National Rental Affordability Scheme) – This is a federal government initiative designed to tackle the issue of affordable housing where investors receiver a tax incentive to provide housing at below market rental rates. Again, a very specialised type of property.

The lesson from all of this is that if you want your property portfolio to outperform, you need to own the type of property that will appeal to a wide demographic of owner-occupiers who in general make up the bulk of purchasers, tend to buy emotionally, pay higher prices and push up the price of properties similar to yours.

To top it off, these are the types of property the banks are willing to lend 80%, 90% or sometimes even 95% on.

Now that’s interesting isn’t it?