Eight sure-fire ways to lose money in property

I’ve heard it said that investing in property is simple, but it’s not easy.

Now this is not a play on words. Let’s face it: each year hundreds of thousands of Australians turn to property investment as a way of developing financial freedom, or getting more choices in their life or building a retirement nest egg. But very few achieve their goals.

Let’s look at the facts. About one in four property investors sell their property within the first year and almost half have sold within five years. Of those who remain in the game, less than 10% own more than two properties and less than one in 200 own six or more investment properties.

Putting it bluntly: most property investors fail to reach their objectives.

My concern is that in the current environment, this will only get worse.

The good news is that there is a way to make property investment work. I’ll explain how in a moment, but first let’s look at eight sure-fire ways to lose money in property.

Currently our property markets are a confusing place, yet property investors are being bombarded with messages of easy money which leads to a worrying trend where some investors are so keen to do something, or do anything, that they are heading for property investment disaster.

Even if they don’t have enough money, or haven’t developed the discipline to save, or they’ve already borrowed to their limit, some potential investors feel they’ve got to do something and in their bid to get into the property market, they are now speculating rather than investing.

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.

So here are eight ways to lose money in the current property markets.

1. Off-the-plan purchases

Sure, it sounds enticing: buy at today’s price then settle or on-sell at a profit in a few years’ time. Sound’s good, but does it work?

One of the big issues with buying off the plan is finance. Since loan approvals are only current for three months, obtaining a formal pre approval for an off the plan purchase is impossible. The problem is when the project is completed; some purchasers will be unable to obtain finance and have to sell. Others never planned to settle but intended to flip their property for a profit.

What this means is that when many projects are completed there will be a group of desperate vendors who lower their prices to sell at whatever the market offers.

And even if you are one of those who will be able to settle your purchase, the banks will only lend you against the prevailing market price of your property, which will be the lowest sale price achieved by one of the desperate vendors, rather than the price you paid.

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 situated, 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 about completion dates, the level of finishes and the market conditions when you eventually take possession. This means is you should buy your property at a significant discount to make up for these unknowns. But currently to get development finance, developers have to sell their products to you at a premium, not a discount.

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, I like buying properties in buildings that have a good proportion of owner-occupiers in them. I 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. But when you think about it, when buying this type of property usually the land accounts for less than half the purchase price, giving these properties a very low land to asset ratio.

While they may be great places to bring up a family, in general new or outer suburbs are not good places to invest. Residents in these areas tend to have less disposable income than people who live in more affluent suburbs which means that these areas suffer most in tough times or when interest rates rise.

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.

3. Buy renovate and sell a property

I’m all for adding value through renovations; but you can’t buy a property, do minimal work and then sell it at a profit, because stamp duty, buying and selling costs and tax eat away at your profits. On the other hand, buy, renovate and hold in the long term is a great investment strategy.

4. Positive cashflow properties

If you’ve been following my blogs you will realise I believe the best way to financial independence through property is to accumulate assets. In Australia, properties with higher capital growth usually have lower rental returns. Sure, owning this type of property requires more discipline, but you can’t save your way to wealth with a few dollars a week positive cashflow.

5. Options

Another way to lose money is to follow some of the creative schemes currently being promoted by property spruikers. People with little or no money are being tempted by the prospect of bypassing the step 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 when you buy using an option.

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.

6. Rent guarantees

This is where the seller or the developer guarantees a certain rental for a period of time. This panders to inexperienced investors concerned about vacancies, but these guarantees come at a cost. Don’t be misled - they are factored into the purchase price and you’re paying the developer upfront for the rent he’s going to repay you over the next few years.

7. Regional properties

I admit that some regional towns have exhibited better growth than some underperforming suburban areas; but on the whole capital city properties have outperformed other types of properties in the long term. Since two important drivers of capital growth include strong population growth and having a diverse strong local economy, I only invest in capital cities.

8. Investing in mining towns.

Yes I know we’re going through the mother of all resources booms and mining towns will grow in the future. But if history repeats itself, and it usually does, the property market in these towns will be driven by speculative investors. While there are likely to be some short-term booms, property prices in these towns tend to be very volatile. Don’t believe me? Try selling your property in one of these towns today and see if you find any buyers.

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

There is one proven, time-tested method that has made average Australians very wealthy…

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 well located 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. Then over time borrow against your property’s capital appreciation and grow your portfolio one property at a time.

That’s what the small group of investors who have achieved financial independence through property have always done.

Michael Yardney is a best selling author and one of Australia’s leading experts in the psychology of success and wealth creation through property. He is Australia's most published property author and has probably educated more successful property investors than anyone else in Australia. Go to www.metropole.com.au