It’s common for investors to get caught up in hype or act hastily out of fear of missing out. As a result, they skip over or rush through their market research and property assessment.
I’ve blogged regularly on the importance of research and due diligence when investing in property.
Risk is one of the biggest obstacles to investment for many property investors. Everyone has different comfort levels – some of us are prepared to take greater risks for greater returns, others are happy with lower returns if it means lower risk.
Risk assessment is a critical element of the purchasing process, but how many of us really undertake comprehensive due diligence?
It’s common for investors to get caught up in hype or act hastily out of fear of missing out. As a result, they skip over or rush through their market research and property assessment.
For others, a full understanding of the risks, getting comfortable with them, knowing the worst case scenario and how they would deal with it is the only way they can overcome their fear and take the plunge.
Risk evaluation can seem a very daunting thing. I have provided comprehensive lists of research areas in past blogs. This time, I thought I would suggest a more simplified due diligence process to help make it more manageable. I have split this into two parts. This blog covers the first part - market due diligence. The second part will cover property due diligence.
Right, you have your deposit, you know your borrowing capacity and you have your investment strategy in place. You’ve done some initial groundwork and, depending on whether you’re seeking cash flow or capital growth, you think you’ve identified some potential markets. Now it’s time for the nitty gritty.
The five questions to ask yourself when doing your market due diligence:
1. What will drive market growth?
For our investments to deliver us strong yields and/or capital growth, we need demand for accommodation in our chosen area to outstrip supply. This requires us to identify some solid drivers of sustainable population growth. Local and state governments often publish economic reports on towns, cities and suburbs which provide population and housing projections and predict shortfalls. This information is useful but make sure you look at what factors they are using to reach these predictions, when the reports were published and if they match up with your own research outcomes.
Look for as many of the following growth drivers as possible. These factors can all have a positive effect on population growth and will greatly improve the growth prospects of an investment:
- Proximity to good existing or planned infrastructure and appealing lifestyle amenities such as public transport, shopping and entertainment precincts, good schools, parks, rivers and beaches.
- Urban development and revitalisation projects.
- Industrial development – the more projects the better. Exercise caution with single-project towns – if the project should run into trouble the property market will suffer swiftly and drastically
Where can I find this information? Information on infrastructure and urban development planning can be found on the local council’s website and the state government’s department of planning website.
2. Where is the market at in its cycle?
It’s no secret that the best time to buy in an area is ahead of the growth cycle. Buying in at the peak means you’ve missed the boat. Suburbs, towns and cities will all go through cycles – it’s not difficult to evaluate if the market is a buyers market (what you want) or a sellers market. You just need to know where and how to access this information.
Where can I find this information? Source historical sales information (for a small fee) from the relevant state’s statutory authority on land information. For example, Landgate if the property is in WA, Land and Property Information if it’s in NSW, Land Victoria etc.
For historical listings data, you should be able to request this from your state’s Real Estate Institute. Run a comparison of the number of properties for sale and the number of properties sold over the last six months, 12 months, two years and five years. This will give you a comprehensive picture of the market’s cycles and what stage of the cycle the market is currently in. An increasing number of listings and a decreasing number of sales indicate the market is in a downcycle creating a buyers market.
3. What residential development is planned?
Any increasing demand for property in your identified area will be greatly softened if you haven’t accounted for increasing supply. Find out what residential development is underway or planned for the area.
Where can I find this information? Information on land releases, development areas, planning applications and building applications can be found on the local council’s website.
4. What type of housing will be most in demand?
To determine the type of rental accommodation that will be most in demand you need to know what type of people make up the local renting market.
Where can I find this information? Council websites and the Australian Bureau of Statistics (though be aware this information can be out of date) can usually provide you with information pertaining to the area’s demographics, type of housing and the proportion of the population that is renting. But to ascertain the demographics of the renting population, you’ll need to speak to several local agents. They will be able to provide you with a profile of typical renters in the area which will enable you to identify the type of housing most likely to be in demand, whether it be houses, units or apartments and whether there is a preference for new or older style accommodation.
5. What is the worst case market scenario?
Understanding and planning for the worst is an essential step for stress-free investing. A solid back-up plan that you can easily initiate if the going gets tough will give you complete peace of mind. The worse case scenario with any property investment is negative growth and a vacant property.
How do I plan for it? Property in general is a fairly low risk and stable investment. Having done thorough due diligence to this point, you should be in a position to make a well-informed decision. But successful and experienced investors know that you still need a plan B. You need to know your financial limits.
For example, if you plan to negatively gear a property, at point would you no longer be able to afford the interest payments if rates were to rise or the rent dropped? Reducing the risk of not being able to afford your monthly payments is one reason why positively geared property has risen in popularity in recent years. But regardless of gearing, how long would you be able to maintain the interest payments with no rental income if the property was vacant? A rule of thumb is to give yourself a buffer in case of emergency by having the equivalent of four weeks rent in a savings account.
Taking the time to work through these key points will arm you with the knowledge and understanding required to make an informed decision on where and when to buy. Investors who do their due diligence stand a much better chance or getting their investment purchases right the first time and creating a successful portfolio sooner.
Reproduced in full with permission: Smart Property Investment April 2014.
Attention: This article is intended to provide general information only. Every attempt has been made to ensure the accuracy of this information at the date of publication. The opinions expressed in this article do not reflect those of DHA, its staff or agents. Property prices are subject to fluctuation. Prospective investors should seek independent advice. DHA will not be liable for any loss, damage, cost or expenses incurred or arising by reason of any person relying on information in this article.