Buyer beware the bargains

Limited cash flow and equity mean many first-time property investors feel the need to chase down a bargain to enter the market. But, like most things in life, you usually get what you pay for, which – in the case of property – can mean unrealised returns or even losses. While there’s nothing wrong with paying less in the hope of making more, investors need to understand when a cheap property is truly a bargain and when they could be selling (or rather buying) themselves short.

Here’s our guide to help investors actually get what they bargain for.

There’s always a reason a property is selling cheap. Your job is to find out why.

Some reasons are obvious – the property is on a main road or backs onto a railway line – but others may be less overt. There could be termite damage, rising damp or shifting foundations, which perhaps only a property inspection will reveal. While not irreparable, these can be big-ticket fixes and probably beyond your reach if you have limited funds.

Other factors may be even more concealed. For example, a very small property with poorly placed sewer pipes that prevent extensions, a new flight path planned for overhead or a property in a high-risk flood zone. These are variables you can’t control and should probably be avoided.

The best way to avoid being sold a lemon is to do your research, not just on the property for sale but on others in the vicinity. What’s the average price for similar properties in the same suburb? And what do they have that yours doesn’t, or vice versa (as in the case of aircraft noise).

That’s not to say all cheap properties have sinister secrets. Some are under-priced because the owners need a quick sale or the property is part of a deceased estate. Keep in mind, though, these sorts of genuine bargains tend to get snapped up quick, so have your suburb research on hand to be in a position to pounce.

Even in the property market there are lemons that can be turned into lemonade. It’s a matter of knowing which lemons are worth squeezing, which means accepting what can and can’t be fixed.

What you can fix

✓ Minor noise (with insulation and double glazing).

✓ Interior design.

✓ Configuration of rooms (turning a study into a bedroom or vice versa).

✓ Storage.

✓ Natural lighting in a house (add a skylight, windows or glass doors).

✓ Under-cover parking for a house (add a car port).

✓ Landscaping.

What you can’t fix

✗ Location.

✗ Land zoning and covenants (restrictions on height, building type etc).

✗ Land size.

✗ Traffic.

✗ Infrastructure that imposes on your property (e.g. power poles).

✗ Flight paths.

✗ Aspect (which way the property faces).

✗ Natural lighting in a unit (you won’t be allowed to add windows).

✗ Unit block exterior (although you can try and influence the body corporate).

Just because a negative, such as traffic, is beyond your control, the property may still be worth pursuing at the right price. You just need to accept it may be harder to rent and harder to sell, and will probably take longer than desired to increase in value. One of the biggest mistakes investors make when they purchase cheap properties with “unfixables” is to over-capitalise on renovations (see our story in this edition on this very subject). There can be a temptation to compensate on what can’t be fixed by over-investing in what can. If you decide to invest in a bargain that has some obvious drawbacks, do your homework on which renovations will give you the best return on investment.

As with all investments, you need to weigh up your personal finance goals and individual circumstances before settling on a property. For many investors, a bargain buy (even with some of the unfixables) is going to be their best opportunity to gain a foothold in the market. It’s worth considering, though, whether settling for something cheaper is the best strategy in the longer term. A slightly more expensive property in a quality suburb with higher growth potential could be worth the extra stretch up front if the capital gain over time far outstrips a bargain buy elsewhere.

Buyers should also be wary of towns or suburbs billed as the “next big thing”. Where there’s a boom, there can also be a bust. Towns built on the back of mining are key examples of property markets that can lure investors with promises of high rental returns. But if the mine dries up or goes belly up due to external factors, you could be left with a property that is worth much less than what you paid with few prospects of tenants.

The key to taking a longer term view is patience, and ensuring you are in a financial position to stick to your plan, especially if it means holding onto a property for 10 or more years to realise its growth potential.

Your broker can help you assess your individual circumstances to determine what you can afford. Everyone’s circumstances are unique so it’s important your first investment takes into account your earnings now and into the future, plus any significant lifestyle changes that might affect your ability to service a loan. Are you planning to start a family or travel? Do you have kids in private education? It’s important to weigh up all of these factors when considering your financial future.