A Lesson In What Not To Do
Today I’m going to share a story which is sadly very common and while it pertains to property investing specifically, the lessons here apply to all forms of investing.
A great investment?
Like many investors of their age, Richard Swanston (aged 52) and his wife bought an investment property with the aim of it helping in their retirement. It was an off-the-plan purchase, and in Richard’s words “It’s a lovely apartment in a lovely complex where we are in South Yarra”.
For anyone not from Australia, or not from Melbourne, South Yarra is considered a ‘premium’ area. It is known for being trendy, with great shopping, restaurants, nightclubs and a thriving café culture.
I actually lived in this suburb for a few years when I moved to Melbourne the first time.
It’s not quite as upmarket as Toorak (one of Melbourne’s most famous suburbs, which Wikipedia states is ‘synonymous with wealth and privilege’) but it’s definitely very desirable.
So, with area in mind, so far, you would think this was a good purchase.
Furthermore, the unit was positioned near a train station – which is generally a really good feature. Proximity to transport is usually something you should look out for in an investment.
And knowing South Yarra, I agree with the sentiment that there are a lot of great amenities here too. It would be a really comfortable and convenient place to live.
So with all these ‘positives’, what went wrong?
Clearly, something has gone astray, though, if Richard and his wife subsequently saw their investment drop hundreds of thousands of dollars in price.
Let’s look at what happened.
Richard and his wife bought the unit 11 years ago for $691,000. They have just sold and the sale of the unit settled to the new buyer on Monday. The price they sold for was $535,000.
He estimates, when also taking into consideration his holding costs (it was also negatively geared), that they have conservatively lost $200,000.
Richard tells us he had been toying with the idea of selling five years ago, but he was concerned at the time, because that would have made him a loss.
So he decided to hold on, and hope the property’s value recovered.
Since then, prices have only fallen further.
To save you doing the sums, after 11 years, when considering price alone, they sold for $156,000 less than what he bought for.
Holding was clearly a mistake, in hindsight.
The reasons prices fall
Let’s look at the issues with this investment, one by one, and see why this result was completely predictable.
In this case, Richard and his wife made a few key errors.
- Supply
This first issue is a major one. What Richard didn’t recognise at the time of purchase, was that there were a lot of other units being built simultaneously, or shortly after, his building was constructed.
This is big risk when buying a unit in a capital city. Units are generally easy and cost-effective for developers to construct. When an apartment building goes up, a lot of units flood the market.
If you have an older unit, and newer units are built with better specifications and just less old, the value of your unit inevitably is affected.
This is a key reason why I never advocate to buy-and-hold units as investments.
- Demand
This is another big one. Coupled with the over-supply, there just hasn’t been enough demand for unit-buyers and so with the supply-demand dynamic mismatched, prices have to drop.
Sellers need to sell. Buyers can be choosy.
If all the units on the market are the same, the only feature that will help hasten a sale is price.
And so prices fall.
- Wrong buyer segmentation at the time of sale
Another key mistake that is very common, is the assumption that the kinds of buyers who will want to buy your property, will be buying, when you want to sell.
Units of this kind are attractive to investors like Richard and his wife.
They are generally low-maintenance, especially when they are new.
Usually they are able to be rented fairly quicky, especially in a rental market like we have today.
So, being easily tenanted and no/low maintenance makes properties like this pretty low-hassle.
Ideal for many investors.
However – if you want to get the best ‘bang for your buck’, you want to be selling to owner-occupiers not investors.
Owner-occupiers become emotionally invested in the home they are buying and therefore will usually be prepared to pay a premium (when they fall in love with the home).
Investors will generally only buy based on the yield (how much it rents for relative to the purchase price) and the potential for growth (capital gains over time).
Investors therefore usually prioritise a low price over most other aspects while owner occupiers will pay more (and therefore make more money for the seller), if they have a reason to buy.
Unfortunately, in the current market, owner occupiers are picky and need to really value a property, to buy it. House prices have skyrocketed but unit prices have dropped.
Investors currently are being even more picky than owner-occupiers.
So both classes of buyers need a good reason to buy.
Which leads us to the next point.
- Desirable, but not desirable enough
To stimulate demand for a specific property you need value and you need scarcity of whatever the value is, that your property brings.
Richard’s unit had value (region, location, proximity to transport and shops etc) but these value-features had no scarcity due to the excess of other units in the area, offering the exact same thing.
Had Richard bought the penthouse, it would likely have been different, because the prestige of this feature, the views, and its scarcity (you can only have one or two penthouses per building) all help drive its premium price.
This wasn’t the penthouse, though.
Without exceptional value and scarcity, this investment is comparable to all the others hitting the market at the same time.
So it’s competing with all the other units on the market, to find a buyer.
- Buying off the plan – without value-add potential
Finally, the last mistake Richard and his wife made, was buying off the plan.
Don’t get me wrong, sometimes you can do well buying this way.
Usually, investors don’t, though.
If you can find a developer selling the last of their stock on a project, they have already made their money on this development. Often, then, they will discount just to move these properties on, to then focus on the next project which will make them more money. (This is more common on completed buildings than off-the-plan sales, however).
Or if a developer is seeking pre-sales (the first sales of the project that they need to secure to get finance for construction) then they will sometimes discount to a low-market price, in order to get the sales they need, so they can advance to starting their build.
However, in most cases, when you buy off-the-plan, you buy at market price and so you pay the same as everyone else.
This is OK, but there is one drawback – the developer has done all the work to optimise the value of the property, leaving nothing that you can do to make it worth any more.
And they have already priced in this value when they sold it to you.
So you are stuck with hoping that market growth alone will drive the future price of property.
And in this case, for Richard and his wife, it didn’t. 🙁
So what are the learnings here and how can this apply to all investments?
The lessons here are that when you buy any new investment or asset, you need to consider:
- Current and future supply
- Future demand when you might be considering to sell
- Who the likely buyer(s) will be at the time of sale, and will they be buying
- What is the unique value that your investment offers to future buyers
- How scarce is that value
- How can you value-add to the investment to maximise your profits at sale.
What everyone needs to remember is that in order for the price of an asset to rise, not only do you need equal or lower supply in the future when you sell, you also need equal or higher demand.
Future conditions need to be more favourable than they are at the time of purchase.
So what will change in the future such that the supply/demand dynamics will have changed in your favour?
AND (this is an important ‘and’) who will the buyers be and why will they want your product when you come to want to sell?
Get these things right and hopefully you can make a bunch of money in your next investment, instead of risking the outcome that Richard and his wife unfortunately had to face.
