What are the red flags for high risk properties that investors need to be aware of before committing to the purchase of a property?
Aug 07, 2017
There are risks associated with the suburb and risks that are associated with the specific property.
The number one risk is taking advice from a property professional who is not paid for their services. In this industry no one works for free. As a general rule, if you are not paying, you are not the client and someone else is, for example a property developer.
Suburb related risks are:
1. Poor or unsustainable economic growth
Economic growth is the number one success factor. Therefore, suburbs that are located in a region with poor or unsustainable economic growth are highly likely to underperform the national benchmark.
A low proportion of new properties has a strong correlation with solid capital growth. Therefore, areas with a large number of dwellings in the pipeline and building approvals are highly likely to underperform the market. Both equity risk and cash flow risk associated with properties in such areas are significantly higher than areas with a low properties on new dwellings.
3. Lower medians
Based on our research properties in suburbs with a lower median price generally underperform suburbs with a higher median price.
4. High unit to house ratio
Where a unit costs more than 60% of the median house price in the suburb, the capital growth was generally lower than units in suburbs where the median price was less than 50 per cent of the house price.
5. High vacancy rate
Properties in areas with a higher vacancy rate carry higher level of equity risk and cash flow risk, as a large number of landlords compete for a small number of tenants.
Property related risks are:
Property type: House/Semi/Townhouse/Unit
Generally there is a preference for houses over units to deliver a solid capital growth. However, the risk associated with a unit or other property types depends on the specific suburb, which is why it should be assessed on a case-by-case basis.
High rise vs small unit blocks
High rise buildings normally carry a higher risk than small unit blocks from both a capital growth and cash flow perspective. The risk that is associated with a high rise building depends on the specific suburb and other factors such as strata payment and specific property features, all of which should be assessed on a case-by-case basis.
Off the plan vs existing properties
There is the possibility that the value of an off-the-plan property may decrease between the original contract date and settlement. This will result in a capital loss, as the equity in the home could be reduced. The risk is further increased if a pre-settlement valuation for a mortgage loan is less than the original value, as there could be a shortfall in funds to complete the sale. If these funds are unavailable, the buyer might lose the deposit paid for the property. An off the plan property also carries a cash flow risk as the actual rental may not meet the expectations.
Property configuration – number of bedrooms, bathrooms and parking
In various areas, there are different configurations of properties that are desired by buyers and for investment properties, by tenants. A property which doesn't have the desired configuration (of bedrooms, bathrooms, parking) carries an increased risk of lower demand from home buyers and investors during normal market conditions. Generally, large properties that are well suited for families carry lower risks and deliver higher return than small properties that are suited for singles.
Our top three tips
- Perform independent research and be aware of the risks. If things go wrong, you, and you, will have to deal with the consequences. All the advisors do not have a skin in the game.
- Do not take an advice from a property professional who you are not paying.
- Distinguish between the research phase (that should be done by yourself or by a research company), and the execution phase (i.e. the purchasing activity).