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Why small fish are sweeter property investments

Why small fish are sweeter property investments
February 5, 2018 Propertyology Head of Research and REIA Hall of Famer, Simon Pressley

If you had enough cash to buy $1 million-worth of real estate what would you do?

Unfortunately, many people would opt to buy just one property. And, if they lived in Sydney they’d probably invest there because they believe the Harbour City will always be the golden goose.

I disagree!

What to do with $200,000?

An investor who has $200,000 as a deposit, either through cash or equity, could conceivably buy property worth $1 million while maintaining a healthy 80 per cent loan-to-value position.

Now, for me, this isn’t a hypothetical because I recently added $1 million-worth of property to my own portfolio.

However, let’s compare my purchases with someone who invested that $200,000 into one property in somewhere like Parramatta (chosen primarily because the median house price in this middle-ring Sydney suburb is near enough to $1 million).

Of course, with any property investment, research in to the fundamentals and growth drivers of a location is vital whether you’re buying one or three properties. But, investment strategy is different!

A thought process to use in this scenario is to actually think like a sophisticated share investor.

If a share investor had $200,000, and worked in a bank, do you think they would invest all of their money into that one particular bank stock? Of course not, because they’d be putting all of their eggs in one basket.

If something adverse happened to that bank or to the financial sector as a whole, 100 per cent of their capital would be exposed to the resultant poor performance.

Smaller fish

Propertyology apply similar principles to that astute share investor, which means we don’t invest all of our capital in one asset or in one community.

Most sophisticated share investors would break that $200,000 into smaller parcels and invest in a number of different companies across different industries. They do this in order to take advantage of multiple opportunities and to provide a degree of protection from future downturns caused by any number of factors that one couldn’t possibly anticipate at the time of investing.

That is what I do as a property investor and Propertyology buyer’s agents help our clients to do it as well.

In my personal case, I bought a $400,000 property, a $350,000 one and then another one for $250,000 (one couldn’t buy a pantry in Sydney for $250,000 these days).

The cumulative value of my three properties is $1 million. But, they’re located in three different states where each economy is dependent on different industry sectors (education, tourism, advanced manufacturing, agriculture, etc).

If there was a broad downturn in one economy for a period of time, or if something adverse happened at a local level in one location, the blow to my portfolio is cushioned by the economic and local growth drivers in other locations. This is a prudent risk management strategy; no one has a crystal ball!

Investing in properties in different states means that my entire portfolio is protected from localised economic wobbles. It’s not that long ago that New South Wales parliament was akin to a revolving door with 4 state premiers within 5.5 years – it’s no coincidence that NSW property markets were among Australia’s worst-performed during that era.

But, the most exciting thing is that I’m taking advantage of multiple opportunities in different locations!

There is no ONE market!

Let me be clear: these are three real properties in three different states with three different economic profiles – and all of those markets are doing different things at different times.

One of those properties is located in Hobart, which we know is going gangbusters. The $280,000 3-bedrooom house that I purchased in mid-2014 (while every other ‘property expert’ was bagging Hobart) has already increased in value by 30 per cent (and growing) and the rental yield is far superior to any other capital city.

The second property has produced mild growth in the short time that I’ve owned it, which is probably a good reflection of what Australia more broadly has done post-GFC.

The location that I purchased the third property in has been quite flat, which was expected when I bought it 18 months ago – when there was no competition and I could invest in the very best property (at a discounted price I might add).

However, Propertyology’s research suggests that each local economy is on the way up due to a number of factors, including business expansions and major infrastructure projects. Other property metrics show the rental and sales markets are both tightening so I’m confident sustained growth is just around the corner (not that you’ll ever read about the wonderful opportunities for investors in parts of regional Australia in mainstream media).

So, let’s now calculate the cash flow of each property investment decision.

Buying a $1 million property in Parramatta, with an 80/20 loan to value ratio (LVR) and a five per cent interest rate, will require an additional cash injection from the landlord of about $20,500 per year.

If there is no price growth for five years as some market analysts are forecasting that’s $100,000 of cash flow that’s needed but the asset value has stayed the same.

Conversely, my small-fish-are-sweeter strategy that helped me to add three properties to my portfolio, using the same LVR and interest rate, have a cumulative cash flow of $3,500 a year – into my back pocket!

So, those three properties give back $3,500 a year to me in cash – plus, those markets are on the way up, not on the way down.

You don’t have to be a fisherman to know that smaller property fish can indeed make sweeter investments!