Property investing without due diligence

Hi Folks,

One of my property managers, Jeff Hunt, occasionally puts a few personal thoughts together in a newsletter. I thought this article was worth posting here. Bear in mind when you read this that Jeff is located in Epping, Sydney and his remarks are probably based on the state of the Sydney market in June this year when he wrote the article.

Quote:

Have you ever felt puzzled when you see normal rational people do things that they feel is intelligent, yet to you, their actions appear to be so illogical and unwise?

For months now I have been struggling to understand why so many "property investors" appear to be ignoring the fundamentals of property investing. By this I mean that they do not appear to be "reading the property market" and making sure that the "numbers add up". Rather, they appear to be following some type of herd mentality or playing a game of "catch up".

From my experience of property investing, you watch the "trends" for opportunities and you only buy if the specific property you are looking at shows you a profit from day one. If the "numbers" don't add up, then you don't buy. It's that simple.

While driving to work this morning it finally dawned on me why so many people who claim to be property investors have been acting in a manner that I find so confusing. The reason for their illogical behaviour is that they have only been investing for a relatively short time and have never experienced a "down market". They sincerely believe that the property market just keeps going up and that every purchase is a great investment.

For a lot of these people, a day of reckoning is fast approaching. The problems they potentially face may prove to be a double whammy.
On one side - the actual cost of holding the investment property is going up because of rising interest rates and rising vacancy rates.
On the other side - as the property market slows, the property values will be under greater risk of actually falling.
If history repeats itself, these people will then sell their recently acquired investment, blaming real estate as a poor vehicle for wealth creation rather than their own ignorance of the product or sound accounting principles.

Because they don't accept responsibility for their mistakes, they never actually learn from the experience and go on to perpetuate the mistakes with say a hot stock market tip or a plunge on say gold bullion.
It's all a bit like a dog chasing it's own tail. A lot of energy but without any real gain. - Jeff Hunt

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Mmmm... I hope we never see any forum members posting a forced sale on Caveat Emptor. If that happens we may have a real auction on this forum!;)

Regards, Mike
 
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Hi Mike,

Thanks for that post - I am still to get into the RE game and this helps me hold on and wait as my brain keeps telling me to do.

Anyway onto my question :D

Everyone says a housing 'market correction' is coming and I have to say that, with my limited experience from the dot com maddness we all saw happen, I agree.

What I can't find out is what the general feeling is on HOW BAD it will be. Some people say prices will just stop rising and won't go backwards and some others say it will just be bad.

What are your thoughts on this?
What are everyone elses thoughts on this?
 
Originally posted by Mike
.......If the "numbers" don't add up, then you don't buy. It's that simple. - Jeff Hunt

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G'Day All,

It really is that simple......the fundamentals of property investment haven't changed.

The amount of times I have seen people change the numbers in order to reflect a more optimistic outcome, I have lost count.

Buy, when the deal is good, walk away when there is doubt.

It doesn't get any simpler than this.

regards
 
Jakk,

You sound like a true property Guru, How long have you been investing in Property and how many Ip's do you hold interst in?
 
G'Day Rixter,

I have been investing in property for over 20 years, bought my first property at age 19.
Actually, I will rephrase that, I have been "INVESTING" in property for about 8 - 9 years now, prior to that I would call what I was doing, Speculating or Gambling.

I lost nearly everything 12 years ago and had to rebuild.
That's when I started "INVESTING"......about 9 years ago.

Prior to that, I simply purchased property, there is a huge difference between the two.

How many investment properties do I own or have an interest in?

If I am to count each flat in a block as 1, and i will for the purpose of this answer, then the number is now in excess of 40 and I am still adding to this when I find a property and ........"The Numbers Stack Up".

Property Guru, I am not, ....Property Investor, I definately am.

regards
 
Hi Adam,

Firstly, let me say that Jeff Hunt is located in Sydney and his article was written in June. People in Brisbane reading his article may be totally confused as the market there is still buoyant by all accounts.

Will there be a correction in the near future? Correction is too strong a word. A sharp rise in interest rates will cause a correction but I feel the likelihood of that happening is low. I think there is room for a gradual increase in interest rates over the next couple of years but the Reserve Bank has to bear in mind that further increases will impact negatively on business which could lead to job losses.

The IT industry is depressed and further rate rises will not help. So, my opinion, as an investor, is to invest where the growth is running while interest rates are reasonably low. There are probably some opportunities left in Brisbane and some parts of the Gold Coast.

As far as Sydney and Melbourne are concerned I would be doing my homework on bluecollar suburbs because workers on fixed incomes are going to be very vulnerable to interest rate rises and may have to let their homes go in forced sales over the next couple of years.

My last buy and hold move was into Brisbane in April last year and I'm planning my next buy and hold move into Melbourne when the market has bottomed out. Until then it's a case of building up my cash reserves by doing some high return investor deals like some posted on Caveat Emptor.

Regards, Mike
 
Under the banner of "I am a newbie" I am going to admit that I don't understand what is meant by "the numbers stacking up".

Let me illustrate my confusion:

Many many people are investing in property using negative gearing. In fact, in Melbourne and Sydney, I would suggest it is extremely difficult to find property that is positively geared, assuming you don't tip in a massive deposit.

If my criteria for selecting a property was that it must be cashflow positive then yes, it's probably quite easy to "run the numbers" in a spreadsheet and see whether you're either cashflow positive or positively geared.

But what about in the case of negative gearing? Sure you can have a negatively geared property that is cashflow positive, but I don't know how common that is.

The general premise (as I understand it) of negative gearing is to incur a negative cashflow today with the premise of strong growth negating that in the future.

In a situation like this what numbers does one look at to know "if the numbers stack up", because whether the numbers will stack up or not depends on future growth, which is not yet known?

Of course, we might use historical growth figures as a potential indicator, but is that enough?

I guess on one hand it would be easy to simply say "Don't negatively gear". I don't think it can be dismissed that easily, however - particularly when respected property investors like Jan Somers are essentially touting negative gearing as the vehicle for building wealth.

Perhaps someone might like to share an example (hypothetical or otherwise) or what stacks up and what doesn't.

BTW, is this what the Somersoft PIA software does (as best as it can)?
 
Can of worms

In Sydney the numbers stack up or don't when comparing two or more investments. These can both be currently on the market or a current and previous investment.

I.e. I look for an investment that is "better" than something else on offer when "All else being equal".

There's also the situation where you are comparing dissimilar ip's

Say 1 br inner city low rise unit with 3 br fringe suburb house. Which investment best suits your objectives. The numbers make sure you aren't picking the one with the blue roof coz it looks nice while sipping Chianti.

Having said that number-gazing in negative gearing is about as sound as using feng-shui or colour therapy. This form of numeromancy is for the analyst sleep easier with their decision.

Negative gearing 100% of a portfolio involves lots of spreadsheets with "a miracle happens" as one of the formulas.

:cool: I am only being slightly cynical here - must be tired

Regards

Paul Zag
Dreamspinner
 
Paul:

But the fact remains is that many property "investors" get into it through negative gearing. I would also suggest that the average investor getting into property investing does not rush out and purchase 10 properties, some positively geared and some negatively geared, they usually start with one.

My point exactly is that negative gearing anticipates growth (miracle might be a bit strong) but the point is that said growth is anticipated, not a given.

So if someone is considering negative gearing what should they be doing to determine if the numbers stack up?
 
Hi all

Interesting reading. I have 2 Ip's in Bne now but cant for the life of me find anything within 10km range of city which is positive cashflow no matter how much due diligence I have done. where /how do you come across these anywhere. I think I have done ok with my latest purchase which was 185K purchase price in June and just had bank valuation for finance which came in at 205K. I recieve $1000.00pm rent. Rents are still soft in BNE so how I get this positive without negative gearing I dont know. My other IP is also neg geared to make it positive.

I read with interest that its not wise to have too many neg geared IP's-should I stop investing until I find a positive geared IP???? I will be ready to purchase again in May next year. I dont believe in trying to play the cycle game-rather I follow Jan's advise and buy a 2-4 rated house at a fair (if not below market price). I also have a crude but simple view in that in 10 years time my property will be worth more than it is today (and what I owe on it) and with a line of credit account-any changes to intrerest rates etc should not effect my cashflow and therefore ability to hold onto my IP's.

I have done significant market reasearch in the areas I invest in and cant see anything positive. Anything extra I could do as I feel like I am making a few mistakes here.

Thanks

ST
 
Must agree with Jakk.

Do the numbers and act accordingly.

How bad will it be?

Unlike the share market, 60 odd % of properties are owner occupied, so there will not be any panic selling, unless people cannot afford to hold. On this note, our economy is ok and employment as well.

As an agent, I am scared by all the speculative stock coming back on in Docklands!

Oversupply will be the big issue in the next 12 months but only in certain areas, so be careful what you buy.

The winding down of the grant has had an impact on demand.
This is fantastic!!!!! What a great time to buy.
You may also find that bad property will suffer the most, whilst good ones will still be in demand. Hint hint.

Just rolled up to an auction which I thought would sell for $230,000 and was the only one there. Bought it for $210,000.

Long term perspective will iron out any market cycle fluctuations. Yes they do occur.

On a lighter note the best advice I can offer came from a wise old landlord: "Never make investment decisions on your gut feeling because we all know what comes out of your guts"

Cheers,
Sam.
 
30th October 2002.

To: Mike

From: Jeff Hunt

Re: Property Investing.

Thank you for your recent email.

A young person might be more aggressive in their investment strategy than myself ( I’m 50 years old ) however I do not advocate buying an investment property just to minimise ones tax bill. The primary purpose, in my opinion, is to acquire an asset that steadily increases in capital value and produces a passive income stream.

A negative cash flow is only acceptable if the opportunity for higher than normal capital growth is realistically expected ( because the property or the immediate area is due to be upgraded or rezoned ) or the purchase was made well below value.

Negatively geared purchasers tend to be structured that way because the investor is under-funded and often impulse buying. Certainly, some investors structure their purchasers with a more adventurous gearing ratio, but this creates potential problems if rental income is reduced or interest rates rise or investors have a reduction in their first string income.

When I refer to the “numbers don’t add up”, I am saying that the combined outgoings are too high for the projected rental income. The outgoings are items such as mortgage interest, council rates, water rates, strata fees, land tax, repairs, management fees etc. For example, an investor who buys a property on 95% finance at say 7.5% on the basis that the net rental return is 2.5% is not wise, because:-

1. He is losing money straight out of his/her pocket from day one.
2. Losing money to gain a tax benefit is still losing money.
3. The gearing ratio is too high risk. All it takes is for interest rates to rise, tenants to vacate and property values to fall and this investor is in deep trouble. All these events are likely to occur over the next 12 months, so the risk is too high in my belief.

I always carry a calculator in my top pocket and the first section of the Saturday Sydney Morning Herald I read is called “Commercial, Industrial & Investment Property” found at the back of Section 3 in the paper. I look at the numbers ( the rental income, the projected net yield, the suggested purchase price ), the location, the possibility of adding value, the risk v’s potential gain, the suitability of a particular property for my personal wealth creation program. You see, I start with a strategy, and then look for properties to fit my program, not the other way round.

I know that it is difficult to find positively geared property in Sydney today. That is one of the reasons I personally prefer to buy commercial properties for investment.

My recommendation to our clients is to invest sufficient capital in a purchase so that they retain control and sleep better at night. This strategy may sound a bit over-cautious but it reflects my view that property investment isn’t something quick and sexy, it’s more a long term program of wealth creation.

I predict that property values will fall during 2003 and a lot of financially uneducated people who have neither the courage or the funding to sustain a period of negative cash flow will have to sell over the next 18 months and that will create opportunities Mike for investors like yourself.

I respectfully suggest patience. If property investing is so easy, everyone would be doing it successfully. The reality is that there are more losers than winners.

There are no miracles but my wife and I are living proof that if you exercise restraint, look every day, crunch the “numbers” on every likely deal, you will find the gem that no-one else can see until after you bought it and polished it up for all the world to see. And then the world will tell you how lucky you were that you bought the very last “gem” and that there will never be another one. But more gems will reveal themselves to you later if you have sufficient self-discipline. Have faith and stay focused.

Mike, I hope that my above comments prove helpful to you and answer your concerns.

All the best.

Jeff Hunt
 
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Thanks Jeff

Jeff -

Everyone I know seems to have jumped on the negative gearing bandwagon, so it was a refreshing to be reminded about capital growth and passive income streams.

The one thing that I'd like to see mentioned more often in some of our forums are margin calls (or more specifically, how to avoid them).

I was also interested in your comments regarding commercial properties vs. residential. Any more tips in that regard?
 
Dear Mike,

I saw my first commercial investment property purchase as a natural progression from my earlier dealings with residential property.

I got into it because :-

1. Of my knowledge of and immense faith in the Epping area as an investment vehicle.
2. My frustration with having to look for and the deal with new tenants every 6 months or so in my residential properties.
3. Of the constant repair requests from tenants.
4. The traditionally low investment yield associated with residential investments.

I have not found a good book on the subject. I listen and watch constantly to keep informed. My personal experiences help tremendously. A bit like “on the job” training.

I suggest that you learn as much as possible in the geographical area you live in and put that knowledge to good use. Most property investors only have one investment property and never progress to commercial. The dollar entry also acts as a deterrent.

Commercial is based on:-

1. Yield ( as a going concern – just like any business venture). Understand too Mike that typically, a commercial tenant pays all the outgoings ( e.g. rates, land tax, insurance, repairs, maintenance etc in addition to their rent PLUS the rent is automatically increased by say 3% to 5% each year to keep pace with inflation ) so the true net yield is normally substantially higher than residential and a highly geared property can actually produce a positive cash flow from day one ).
2. The potential for further development – either alone or in conjunction with adjoining sites.
3. The quality of the tenant.
4. The terms of the Lease ( e.g. the Lease period is normally 3 or 5 years, not 6 or 12 months as is the case in the residential market ).
5. The current and future demand for the location.
6. The ability to have various tenants in the one property – creates a more stable income for the property owner.
7. Its propensity for a higher capital growth rate than residential property.

It is impossible for me to give you all the information you need via this medium. That is why people employ me. Its cheaper, safer and faster to delegate than try and be an expert in everything.

Regards
Jeff Hunt
 
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