Your Money

5 warning signs that a property may be a bad investment

- July 13, 2021 6 MIN READ
Investment property warning signs

There are definitely some key property investment warning signs to keep an eye on. That said, I am a firm believer that when it comes to property investment there isn’t one single ‘right strategy’ that suits everyone. Choosing a successful strategy should come down to your attitude to risk, time availability, skill, and financial circumstances at that time. 

As time progresses and you hit different life stages, that strategy may well change and that’s ok! There are however some signs that are a red flag that you could be heading down a path of disaster. I’ve come across these again and again in my years of investing and learning from other professionals. Here are my top property investment warning signs.

1. Relying on hotspots

The first of my property investment warning signs to look out for is relying on hotspots. The key is your ability to pick that hotspot and to pick it early. Get it right and you may make a fortune, but get it wrong and you may have bought a lemon that won’t rise for years to come.

The majority of property investors are investing for the sole purpose of financial gain. If you can purchase a property in a suburb that is just on the verge of going through a property boom, then you are likely to quickly make a substantial profit.

Markets can really grow at 20-30%+ per year when there is lots of competition for a scarce resource. So a herd mentality appears, even in risky areas.

Many hotspot areas are far out of capital cities and the reason they are booming is because a new industry is planned or even a new transport link. However, can you guarantee that this will actually happen?

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Another danger of having a hotspot strategy is that you’re a victim of short term investing. That is, you concentrate on the return you get for the next 1-3 years and ignore your return over 10 years+. Property is very expensive to get in and out of with 5-6% costs of purchase, 2-3% cost of disposal plus the capital gains tax implications. So trying to get in and out of the peaks and troughs like you would in a stock market is very difficult.

As a result, hotspots are often not as rewarding as buying in a good area that gets consistent growth and holding on forever.

If you are going to go for this type of strategy, ask yourself these questions:
  • Why am I buying in this area?
  • What are the growth drivers for this area and how likely are they to eventuate?
  • What’s the cost to me if this area doesn’t perform?
  • What return to I need to receive in order to outweigh that risk?

Most investors have full time jobs and don’t have the necessary time to put into dedicated research, especially compared to experts that spend their whole lives doing it full time. I suggest buying some reports from Hotspotting or Residex to confirm your choice before proceeding. It’s a small price to pay for some expert confirmation.

2. The trap of rental guarantees

The fear of many property investors is not getting a tenant or that their tenant will not pay rent on time. So when brand new properties for sale offer a guaranteed rent for up to three years, they think all their prayers have been answered. But have they?

The principle of a rental guarantee is a good idea as it limits your risk of entering repayment difficulties or having your property re-possessed.

However, as with most things in life, sometimes a guarantee isn’t all that it should be and this is how it can all go wrong. If you expect to get a 5% return on your property and the rental return is $500 per week, many investors would be prepared to pay $500k for a property. If a property seller artificially inflated that rent to $550 per week and offered to guarantee it for 2 years, some unsuspecting investors may well pay $550k for the property – overpaying $50k.

The seller may then need to cash flow the extra $50 per week rent ($550k inflated rent less $500 normal rent) x 2 years = $5,200

The seller makes an extra $44,800 ($550k – $500k – $5,200) and the buyer has a guaranteed rent but has overpaid by $44,800.

What can make it even worse is that the guarantee is from a $2 company that then collapses once all the properties have been sold.

Please note, I am not saying that all rental guarantees are a sign that you are getting ripped off. Just that you need to be aware.

If you pay a fair price for a property and get a rental guarantee, then treat it as a bonus. Rental guarantees should never be the primary reason for investing, the underlying property and its location is the most important.

3. Buying in one industry towns

Location is one of the most important factors that will dictate how your property investments perform. As property is typically a long term investment due to the high purchase and selling costs, you need to consider the performance of the location in both the short and long term and the risk factors that may cause it to change.

If you choose a property that is reliant on one main industry then it is likely to carry more risk than an area that has multiple industries supporting it. Think of areas solely reliant on mining, tourism, government or manufacturing.

My suggestion is that if you are a passive investor who doesn’t have expertise in the specific industry that you’re investing near, you’re probably better off investing closer to a capital city. Near capital cities there are usually multiple industries and less vulnerability to a sudden change in the economy.

If you do have knowledge of an area or industry where you can take advantage compared to the average investor, then do make the most of it. But I would still suggest that you only allocate a proportion of your funds into that area, and balance it with some less speculative locations.

4. Property sold predominantly to investors

Another of my property investment warning signs is avoiding buying in a predominately investor-owned area. No matter whether you are buying existing or new properties, there are buildings or areas that typically have owner occupiers, investors or a mixture of the two in them. So what’s best?

Owner occupiers
  • Generally look after the buildings and areas as they care about where they live
  • Are less likely to suddenly sell in a down turn as they still need a roof over their heads – this protects your property’s value
  • Don’t always have the funds to look after the buildings as they are concentrating on paying off their mortgage – for example, many buildings can fall into disrepair where there are  pensioners who cannot afford to fix damages
  • When tough times hit, investment properties are usually sold before people sell their private residences. And often they need to sell quickly. If you’re part of a large complex and someone undersells or under-rents a property, then virtually all other properties get de-valued in that area. This is because buyers, renters and valuers will often look at the last transaction as confirmation of what something is worth.
  • A lot of investors can be highly geared and may not reinvest into a block that is starting to come into disrepair. They don’t physically see it every day and don’t have any emotion about keeping it up to its best potential.  This isn’t always the case, as some investors target these properties and are very keen to render, add balconies or additional levels, but it’s generally true.

Again, there’s no wrong or right here and it’s very much on a case-by-case basis. It really depends on the property and location. I do invest where there are a lot of other investors because the properties are by the beach near the inner city. However, all the blocks are very small.

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5. Large gaps between existing and brand new properties

If your property investing strategy targets brand new properties then sometimes it can be hard for you or even valuers to calculate what a property is worth. Just because 100 other properties have been sold in the building, doesn’t mean properties are worth that amount. They could have all been completely unsophisticated, amateur investors that just assumed they were buying well.

One way to see if you’re paying too much is to see what a renovated second-hand property is selling for in the neighbourhood. Then see how much of a premium you are paying for brand new.

I looked at an example for a client in the past where a two bedroom unit in a very large block with high strata fees was costing around the same as a three bedroom house with a reasonable sized garden just round the corner.

Now, some may still like the brand new property for the depreciation benefits, but the larger house was perhaps more suited to the local demographic of buyers and renters and offered better value. So this is definitely one of the key property investment warning signs to look out for.

Doing nothing will get you nowhere

I think they key for most investors is to go out and at least do something. Sitting on the fence will get you nowhere. It’s impossible to have 100% knowledge of the market and the various strategies available, so at some point you’ve got to jump in.

We all make mistakes and it’s easy to analyse decisions with hindsight, but the reality is if you do a reasonable amount of homework, you can work around any issues that come up.

This is an edited version of an article that was originally published on Your Empire Property Buyer’s Agency and appears here with the permission of Chris Gray.