The Spiderman Interview

Interview with Spiderman – 12th January 2009

How did you get involved in property?

I started quite late and only got into property after 10 years with term deposits, direct share ownership, managed funds and a savings program.
This was successful enough but I wanted faster growth; despite years of saving, income from investments was barely 10% of total income when it should exceed half.
One night about 6 years ago I couldn't get to sleep. An idea was nagging; was it possible to borrow to buy property with the rent covering the outgoings? Scared that I might lose the idea I did some back of the envelope calculations before going to bed.
Risk was an issue, but it should still be safer than buying one's own home as a first homebuyer since (i) the mortgage payments would be covered by rent, not job income, (ii) the price paid and thus the loan would be modest, (iii) any repossession would not make me homeless and (iv) reasonable savings.
Sleep wasn't good that night but the next evening I bought a pile of property books from authors such as Wakelin, Lomas, Somers etc (although I already had some, such as Noel Whittaker's 'Making Money Made Simple').
Property ads revealed that Melbourne was too expensive, with rental yields too low (this was early 2003, at the peak of the previous boom, with massive attendances at auctions and property seminars).
Parts of regional Victoria were cheaper but they were either small towns or the Latrobe Valley whose demographics and population trends didn't look promising.
A holiday, further research and a trip to Adelaide for another purpose made me think I might as well go further. And so it was in WA that I found good properties that approximately paid for themselves in large regional cities.
The property that inspired me was a 1 bedroom unit advertised for $90k with a rental of $180 pw; I saw this on the net before going over. However this was a furnished unit in a large complex a bit out of town. Further searching and valuer general sales data revealed some older unfurnished 2 or 3 bedroom villas in smaller complexes in town sold for about that price. One of these was obviously a better buy.
A well-priced 3-bedroom unit was found on the web and still available when I arrived. Another agent had told me that properties in that price range and area were 'impossible' so full asking was paid for an instant 9% yield (soon 10% as the previous rent was cheap). Interest rates then were a bit over 6% and the property was built in 1988 (building depreciation obtainable) so it has cost nothing to own.
Six months later I still had heaps of holiday owing at work so it was time for another trip to another city (didn't want all eggs in the one basket) and picked up a similar buy near the beach. Another six months and the process was repeated in the first town. Shortly after WA prices shot up and subsequent purchases have been local since the properties were cheaper and the yields no worse.

What is your property investment philosophy (CF, CG, renos, houses, flats, buy and hold, develop, flip, wrap, etc)?

Cashflow or capital growth? A mixed approach, avoiding large negative cashflows, has always been followed.
Conservative debt levels (around 50% LVR across portfolio, but up to 70-90% for individual properties) and buying on above average yields have ensured that any shortfalls are small and the portfolio is about neutrally geared despite varying interest rates. Yields on purchase have varied between about 6 and 9% (metropolitan and regional respectively). Rising rents have made some positive cashflow.
This policy minimises losses when the market is sluggish, ensures that the portfolio can withstand all phases of the economic cycle and avoids forced sales. It also makes you a good lending prospect for buying more!

Buy and hold? Yes. With the occasional sale to reduce risk or take advantage of better value elsewhere. Use has been made of equity gained in earlier purchases to fund later purchases.

Renovations? Only minor improvements, such as painting and fencing, to date. A front picket fence, where none was there before, makes a world of difference!

What is your IP / property story so far?

A boring story of gradual accumulation, buying good value residential properties when prudent and affordable to do so.

Is there a story of a really good IP that you would be prepared to share with us?

Two regional city IPs stand out due to high capital gain and rental yields over a four year period. However I believe that growth rates generally revert to a mean and slower growing parts of the portfolio will eventually shine,. Those two IPs that did so well in the past may likely be average or below average only in the near future.
Apart from the lack of any inner city property in the portfolio, though still small, has become a fairly representative slice of Australia. This provides stability through diversification but means the portfolio is unlikely to dramatically outperform the national average for property in the longer term. I do not regard this as a handicap since the portfolio has been set up to deliver stable and acceptable returns under a wide range of economic conditions.

Is there a story of a really bad (or not so good) IP that you would be prepared to share with us?

None have been bad.
One regional unit had somewhat higher than acceptable vacancy and maintenance costs. Plus a property boom made it over-valued; houses with more land in outer suburban areas could be got for much cheaper. And it didn't seem right that due to rising prices rental yields in that town had fallen to outer suburban levels.
Hence a decision was made to sell it and buy two houses in a cheap Melbourne outer suburb that represented better value. The rental yield of the properties purchased was above average (but not spectacular) so my value assessments relied on the purchase price being only slightly more than either land value or building replacement cost.

Do you invest in other asset classes (shares, commodities, businesses, managed funds, cash, forex, etc)?

Small exposure to shares and managed funds only. These have not done well lately, but at least they were not leveraged and unrealised losses have constituted only a small proportion of the portfolio. These will be held onto.

What criteria do you use when selecting a property to purchase?

I aim to buy assets that appreciate over time and provide good rental returns.
I will not buy anything that I regard as poor value.
I spend a lot of time thinking about what represents value and what doesn't.
Buying value is incredibly important and is discussed again later.
To date I have found value in houses, half-duplexes and villa units. I have not yet found value in apartments, although it no doubt exists, even in inner suburbs where I've never bought.
Purchases have all been single-storey (for ease of maintenance), brick, 2 or 3 bedrooms and with at least a private courtyard and carport/garage. All have been in convenient locations, at least 10 years old and unfurnished. Buying less than 20 years old is good to get building depreciation but it's unwise to pay too much just to get this as the higher price/lower yield will not compensate.
If a unit they've been in small single storey complexes of no more than four. My belief is that villas appeal to the fastest growing demographic groups, including singles and couples. In country areas building activity has often trailed demographic shifts so a tidy unit can rent better than the typical asbestos, fibro or weatherboard house. In suburban areas builders seem to prefer expensive townhouses over villas, maybe due to security, garaging and resale values.
Apart from their stairs (may discourage older tenants) many townhouse prices and rents are too high and the older duplex or villa-style units offer a better balance between affordabilty and livability for many. Cheaper purchase prices and larger backyards of duplexes (and even some villas) contribute to a high land value component so you're paying less per square metre of land than townhouse buyers. The least amount of common areas, common facilities or bodies corporate the better.
1 bedroom units would also have been acceptable, provided their location is exceptional and larger units are unavailable for little more. While both conditions are met in the inner suburbs they are generally not in cheaper outer suburban or country areas. In a mining area I'd prefer a unit over a house due to the demand by hard-working miners for a low-maintenance pad. But in outer suburban areas where houses on full blocks cost and yield about the same as units I'd prefer a house, due to the better value offered. Newish townhouses have been avoided; with few exceptions these are over-priced for the land obtained and a house on its own block might be a better buy.
Consistent with the above comments about 'value', I've never paid above a town or suburb's median price for a property and will not do so without good reason.
My purchases tend to be a bit below average – say 70-75% of median – because I'm basically a scrooge! Even though the property might be a bit basic, paying below median is attractive because (i) it ensures buying in about the best suburb for the budget, (ii) value-adding might be more fruitful and (iii) the risk of over-paying is reduced. Plus if vacancy increases you'll be able to charge a lower rent than other landlords and be less out of pocket.
There are whole suburbs (especially newer areas) where houses are similar style and price. In other words the median might be $250k with the lower and upper price quartiles $220k and $280k respectively. Something near 75% of median (under $200k) might be really hard to find. And improvements beyond the basics might add less value than they cost.
Instead it might be better to go for a suburb with a bit of diversity since they will include houses priced well above the median, and also, almost by definition, affordable houses priced well below the median. Compared to the first example, a suburb with an average house price of $300k, but also with $200k and $400k houses has a wider range of prices, a higher chance of imperfect markets, and possibly better value buying and value-adding prospects (including large blocks and development sites).

Have you found owning interstate properties has caused you problems?


Risks were mitigated by:

· Having prior knowledge of the state by growing up in it
· Talking to locals (not just estate agents). This requires staying at the backpackers (so you can talk to the owners), riding local buses, talking to local shopkeepers and going for walks along the beach etc. You might even find a jewel in a good suburb that's good value as it's been overlooked by absentee or interstate investors who only bought in the cheapest areas.
· Not buying sight-unseen and spending a week or two over there. Having said that, the two properties that I decided were my favourites before departing both turned out to be excellent buys and nothing seen during the visit was any better. Return visits have also been made.
· Ordering reports on past sales to confirm value was being obtained (I had established elements of a 'two tier' market were present with certain types of units and I didn't want to be part of it).
· Only buying lower maintenance brick homes in handy areas. Ask yourself “If half the town's population left would my property be in the half that still had tenants?” Though I'd buy a cheapie locally, interstate I've favoured handy (but not prime) near-CBD or beachside localities. I broke that rule once with the newest and nicest-looking property ever bought but made amends by selling that one when prices got silly.

I have only bought in interstate, regional or mining cities if the following conditions were met (i) The centre had a decent economy and population with several industries, (ii) the town was large enough to support a choice of property managers and tradesmen, (iii) I could buy good property for prices well under my home city, and (iv) the area has a strong rental market with yields at least three or four percent higher than obtainable in my home city to make it worthwhile (especially if council rates and management fees are high).

The downside of interstate buying is it's harder to organise renovations and you need to take time off work to do things there. This makes buying and holding more attractive than renovating; for the latter your own city would likely have been better.

Buying interstate provided high returns for me purely because at the time properties were undervalued and yields were high. However yields and prices across the country have since become more uniform so the comparative benefits of interstate and country buying (with the possible exception of Sydney) are less now compared to 2003.

If a budding investor asked "what are the top ten investing concepts I must understand", you would say?

1. Understand that the wealth of people on identical incomes varies greatly. The difference is due to their everyday spending, saving and investing choices that when entrenched become habits.

2. The ability to make these choices depend on your control of your money. If you don't control it, it controls you! 'Control' means either (i) strict budgeting, (ii) questioning the necessity, cost, benefit and value of each expenditure before it is made or (iii) automatic direct debits for investing each month. (ii) and (iii) only have been sufficient for me.

3. Spending less than you earn and sensibly investing the difference will make you wealthy or at least financially secure. Concepts of 'opportunity cost' and 'delayed gratification' are important. However the latter is easier if consumer doodads don't excite you much to begin with!

4. 'Investing' means buying good value assets that appreciate in value and produce income (a 'portfolio').

5. 'Investing safely' means building a portfolio that will perform under widely varying national economic conditions and personal circumstances. I reduced risks by seeking higher than average yields, borrowing conservatively and only buying well-located but cheaper properties that people will always be able to afford to rent. I can fairly say that my risk has never exceeded that of the average first homebuyer which I adopted as a benchmark.

6. 'Perform' means that the portfolio grows in value, produces income and is sustainable.

7. 'Sustainable' is related to safety and means that you can hold onto the assets long-term, even during a recession or changed personal circumstances. The portfolio must contain assets of lasting value and return an income sufficient to cover all or most of its holding costs, during good times and bad. A portfolio of overpriced low-yielding assets that you may be forced to sell is NOT sustainable. Avoid marketers who use growth figures from a few 'good' years to make the purchase of low-yielding assets appear prudent.

8. 'Borrowing' or 'leverage' allows you to buy more assets more quickly. This magnifies potential gains; 5% appreciation on $1m of assets is better than 5% (or even 10%) on $250k of assets. Leverage can multiply returns relative to the money put in. Also, even if no principal payments are made the outstanding debt declines in real terms thanks to inflation. If the asset value rises (even if only by inflation) the difference between this and debt increases exponentially, boosting net wealth. However heavy borrowing is risky in that it magnifies losses (especially if interest payments far exceed the yield or asset values plunge) and make the portfolio less sustainable. The most profitable portfolio is the largest one that is sustainable during all economic conditions and responsible borrowing is key to furthering this.

9. The search for value is key to selecting the right assets and minimising the risk of loss. 'Good value' can be subjective, and it's often easier to start by identifying 'poor value' assets to avoid. There are several ways to assess an asset's value, including its industry or location, income yield, comparable sales, land value ($/m2), replacement costs or future prospects after expansion/renovation/development. Before buying it may be worth justifying why your choice represents better value than other assets available. Although there can be cases where you can't express it clearly at the time but the purchase performs above expectations anyway! Imperfect markets can create opportunities for the investor to purchase good value assets. 'Accepted wisdom' is widely mouthed by 'experts' but don't let it put you off your own 'search for value' that may produce different (and possibly better) finds.

10. Seek to understand the propagation of ideas, opinions and sentiment from so-called 'experts' and their effect on 'accepted wisdom'. Think about who is doing the talking, their vested interests and what they stand to gain. Opinion is fickle and following it too closely means chopping and changing your portfolio more often than is healthy (or tax-effective). It's much easier (and cheaper) for an 'expert' to quickly change a 10-second TV opinion than for you to change a portfolio's structure. Besides when you're almost decided on something, things change! As an example, two years ago the general consensus was that the expensive leafy inner suburbs were where capital growth was highest. A year ago when petrol and interest rates rose the pundits predicted foreclosures and big price drops in outer 'mortgage belt' suburbs. Now we are being told the prestige suburbs are suffering big losses but cheaper areas are holding up. Timing always seems better in hindsight, and in real estate location (or in shares, industry sector) is often over-stressed. So sometimes it might be better to ignore the pundits and do very little except buy good value assets that can be held long-term.

If a budding property investor asked "what are the top 5 things I should understand and do", what would you say?

The previous 10 must first be understood since they are general investment principles that I believe apply to all assets classes, including property. Specific to property, I add:

1. Have an enduring confidence in real estate. To me this comes from the fact that people always need somewhere to live. If you buy value homes that are well-located, affordable to rent and don't involve large negative cashflows you are fulfilling a basic need and will not lose. I've stuck to mainstream, even boring, properties. Properties in prestige suburbs, serviced apartments and units in large complexes have all been avoided due to high costs, low yields or lack of control. Interstate, regional and mining cities are acceptable under certain circumstances (above). Small towns carry risks to the outsider but could be great for the local who knows the market well.

2. Understand your chosen rental market so you can better meet its needs. This means being aware of tenant demographics, incomes, what they want and their capacity to pay. Visit an area at least once and preferably several times before buying. Hang around the shops, ride the buses, walk the streets and look at the surrounding suburbs. Some will be very dear, some will be miles from anywhere while others won't be too expensive but have local services handy. Don't rely on statistical averages; look at distributions as well. Only after you examine distributions will you realise that some measures like so-called 'average incomes' are inflated and many people's incomes are lower than often realised.
3. Develop a nose for value and have the strength to act on this in the face of conflicting opinion about a location, property, investing or borrowing. For example buying in an unpopular but sound area and/or gently reweighting your portfolio from assets that you think are over-valued to those of better value can be sensible.
4. Buy in the best area you can afford but avoid paying too much. Conflicting advice? Not if you buy less than median for a suburb. Average prices are just that and in most areas you'll find properties (some worth buying) priced around 70-75% of that median. Set a particular affordability budget and look at suburbs with medians up to 1.5 times that. There'll be at least a few properties around your budget. Eliminate those poorly located or in bad condition and shortlist the remainder to inspect and make offers on.
5. Buy properties that don't unduly restrict your capacity to buy the next one soon after. This means not paying too much, avoiding large negative cashflows by getting a good rental yield and buying in an area with sufficient appeal to appreciate in value. Even if the bank says you can borrow $400k it might be more prudent to diversify with two cheaper properties instead of spending it on one. Understanding the measures lenders use in assessing loan applications (eg DSR and LVR) and the effect a planned purchase will have on them also helps to maximise control over when you can next purchase.
Except for those in high income jobs, cheaper higher yielding properties can reduce the time between acquisitions. Even if such properties appreciate slower than those in 'blue chip' inner suburbs (and this is not always the case), the difference in capital gains will likely be offset by higher yields and having a larger portfolio obtained earlier. To keep growth sustainable, set prudent limits on maximum loan to valuation ratios and negative cashflows and time future purchases accordingly. At the peaks of booms when credit is easy your personal limits may be stricter than the bank's. However this is no great loss since lax lending will have over-inflated asset prices and their value will be poor anyway.

The bigger picture in this is to know your own financial circumstances and needs and pick a property investing approach that matches your financial capability (eg borrowing potential), talents (eg renovating or not) and life goals.

And if that same budding investor asked "what 5 things should I avoid", you would say?

1. Failing to develop a concept of good value and being unable to identify what is and isn't.
2. Unless it's cheap and/or you can add value by renovating buying your own home first is a bad move financially if you want to also buy investment properties. Living in a house you've bought means you forfeit its rental income, are ineligible for tax deductions on interest and costs, and suffer reduced borrowing ability. Reduced borrowing ability reduces purchasing ability and thus portfolio size and possible capital growth. However if it's a choice between buying nothing and buying your own home then the latter is absolutely the right thing to do, even if it only provides forced saving. Home ownership also has certain non-financial advantages and you'll probably want one eventually. But when you do buy note that the smaller proportion of portfolio value it is the less it will harm the ability to purchase more IPs.
3. High purchase prices, large negative cashflows and unrealistic capital growth projections that restrict your ability to buy the next property and/or sustain the portfolio.
4. Being mislead by spruikers and their upmarket 'buyers advocate' cousins since both can have undisclosed investing prejudices that don't necessarily serve your interests.
5. Believing that property investment is a cure for bad personal financial habits, such as spending more than you earn, borrowing for consumer items, living beyond one's means etc or expecting fast returns from miracle schemes (including those connected with property).

And in a slighty different vein - what would you advise the property investor who maybe has a portfolio of properties, but is at a loss as to how to proceed?

Make a decision if it is even desirable to expand or not – this should be based on what they want from investing and the opportunities available. If affordability is historically very poor it might be better to buy nothing or research other cities for better value.

They need to realise that expanding is not a free lunch. Expanding gives greater capital growth prospects but increased risk, especially if borrowing is required and there are heavy negative cashflows or interest rate rises.

Once a decision is made they need to examine their current portfolio and appraise whether its current structure provides sufficiently good DSR and LVR figures to allow further borrowing.

Taking a profit by selling assets that you judge are now overvalued or have large negative cashflows, can release equity and permit new purchases. However it's important that what's being purchased is clearly better value than what's being sold otherwise it might be futile and all you get is a big capital gains tax bill.

What are you views regarding renting or owning a PPOR?

I have preferred to rent a PPOR while buying rental properties. This dramatically reduced living costs and increased serviceability. Do the calculations; in all but exceptional cases this is the best option for those wishing to build wealth the fastest.
Rental income, deductible costs (interest, management and even depreciation), better loan serviceability, higher borrowing capacity and greater flexibility of location are all benefits the landlord gets but the owner-occupier doesn't. Living (and paying rent) in a low-yield inner suburb and having your rental properties in higher yield areas only increases the benefits further.
The only countervailing financial benefits of your own home are the first home owners grant and the lack of capital gains tax if you sell. However the FHOG is still available to those who have bought (but not lived in) rental properties before buying their own home and the capital gains concession is of no immediate value if you don't intend to sell.
Nevertheless you may get to a point where it's 'nice' to have your own home. Luckily, provided you've got a few IPs under your belt and the PPOR price is small in proportion to the total portfolio this needn't be a wealth hazard. Indeed in country areas buying can still be little more expensive than renting and additional benefits may apply if you can improve it yourself and release equity for investment properties.

Do you consider that there is any natural progression for an investor? (eg. From owning a few properties, to owning many, to being a developer)

From my own experiences, yes.

However the progression starts far earlier than that. It starts with a realisation that money is a tool that can be lured to you, harnessed and controlled. If you obey certain rules money will accumulate as savings, ie the excess of income over expenditure.

Once money is saved it can then be invested. Money then breeds itself through interest. An increasing proportion will come from compound growth rather than direct saving. If returns are reinvested the direct saving component becomes less significant and the portfolio fuels its own growth.

The process can be accelerated by through borrowing to buy good assets. However this can introduce additional risks and many of the points above explain how to reduce this.

What do you prefer, fixed or floating interest rates and why?

Except where prepayment of interest was desirable to offset a CGT liability, and this required a choice of fixed, I have always gone for floating interest rates.
I simply cannot predict interest rates and do not wish to make a bet with the bank.
However it's important to have adequate reserves to handle interest rate rises if on variable.

Finally, where do you see the market at the moment and do you think the current environment is making it harder for newer investors than when you started?

I will not pretend to predict how the market will move. But I believe if you can get a property that is 1. good value, 2. reasonable yield, 3. good value asset that people will want to live in then it should work out OK.

Questions and Comments………………….