4 Investments Low-Income Earners Should Avoid

There are certain investments that low-income learners should swerve to avoid, as they have the potential to transform a potential money-spinner into a certified dud. Sarah Megginson uncovers the four investments you should aim to sidestep at all costs

Present-day property buyers are a fortunate bunch, with the luxury of choosing between variable mortgages and five-year fixed rates that begin with a 4.

Those who have been investing for more than a few years, however, remember what it was like to pay more than 8% interest on their home loans. In fact, some investors still own properties today that cost them twice as much in interest repayments to own just half a decade ago.

If you haven’t lived through the sting of this experience, then you may be more willing to “try almost anything to participate in the current market”, says Michael Yardney from Metropole Property Strategists.

“It concerns me that, with all the news of strong property price growth last year, investors can feel like they’re being priced out of the property market, and they’re desperate to get a foothold,” he says.

“Some investors are so keen to do something, to do anything, that they are heading for property investment disaster.”

This is particularly true for low-income earners, as they don’t generally have the financial resources to help them withstand a significant financial bump in the real estate road.

A couple of weeks between tenants may be manageable, but what happens when a property sits empty for three months because it was purchased in a low-demand area? That can end an investor’s wealth creation journey before they’ve even begun.

Before you take the plunge on your next investment, respect and protect your hard-earned investment dollars by pouring your funds into the best-quality property you can afford. That means treading with caution when you encounter any of the following investments.

No-go investment #1: Off-the-plan purchases

 Why is it risky?

It sounds enticing to buy a property at today’s price and then settle or onsell it in a few years for a tidy profit. But many property experts warn that these deals can be fraught with danger, due to the numbers of variables involved – very few of which are within your control.

“Buying off the plan comes with uncertainty about completion dates, the level of finishes and the market conditions when you eventually take possession,” Yardney says.

“Upon completion, some buyers will have to sell because they can’t get the finance to settle, and there will also be some purchasers who never intended to settle as they planned to onsell for a profit. Combined, this results in a whole lot of apartments up for sale when the building is finished.”

It takes just one desperate seller accepting a low-ball offer to drag down the value of every apartment in the building. Factor in a potential oversupply in the local market and your investment will enjoy “very limited or even no capital or rental growth”, Yardney says.

“All of this means you need to buy your off-the-plan property at a significant discount to make up for these unknowns,” he says.

 How can you mitigate the risks?

To begin with, ditch the idea that you’ll be able to make a lot of money by onselling the apartment before you have to settle it in your name.

“Trading property is not the way to become wealthy; accumulating assets is,” Yardney says.

“And even if you could sell the property for a higher price than all the other speculators who are doing the same thing in the same complex, after stamp duty and tax you’d lose out anyway.”

If you intend to hold the property once it’s built, you need to find an off-the-plan development that presents a promising ‘scarcity value’.

This means scratching giant building complexes off your list, as they flood the market with too many of the same types of properties that are difficult to distinguish from one another. This makes it challenging to add value by installing unique features, or to stand out from the crowd when trying to attract new tenants.

“One of the big factors that enhances capital growth is scarcity, and that’s something missing in these properties. There is little scarcity in a block of 100 or 200 apartments,” Yardney confirms.

“Furthermore, many of the large off-the-plan complexes are being built to a poor standard and are likely to be the slums of the future.”

 What's your alternative?

Focus your attention on boutique projects of 10 apartments or less, and look for developments where the buyers include a mix of investors and owner-occupiers.

“I like buying properties in buildings that have a good proportion of owner-occupiers in them, as I find that owner-occupiers tend to look after the buildings better and enhance their long-term capital growth,” Yardney says.

Regardless of the property you decide on, it’s also essential that you don’t invest in an off-the-plan deal without some solid savings or accessible equity behind you. In the event that the property doesn’t increase in value between purchase and settlement, you may need access to additional funds to help you meet your financial obligations.

No-go investment #2: Positive one-trick ponies

Why is it risky? 

Positively geared investments are appealing to low-income earners, as they have the potential to deliver instant profits to your bank balance. But settling for a property that achieves only one goal is far too risky and won’t allow you to create lasting long-term wealth, according to Your Investment Property Mortgage Broker of the Year Jane Slack-Smith.

She believes that the more profitable way to invest is to look for real estate located in a growth area that can be purchased below market value, while also presenting the opportunity to add value.  “Some people are so focused on finding a cash flow deal, but it’s the growth in your portfolio that will allow you to live the lifestyle you want upon retirement,” she says.

“That’s why I support a low-risk strategy that delivers yield and growth, without substituting one for the other.”

Investors who chase yields alone may risk prioritising their short-term financial goals over their long-term vision for wealth creation, Slack-Smith adds.

“Getting a 9–10% rental yield is great, but you’ll need a lot of properties making $100 a week to have enough of an income to support you when you retire,” she says.

 How can you mitigate the risks?

In Slack-Smith’s view, you shouldn’t consider investing in a positively geared property unless it’s also located in a growth area, with the potential to add value through renovations.

“You also need to buy below the market, which you can do by knowing intimately the market and any opportunities when they arise. These properties can be harder to find, but they’re still there,” she advises.

By tracking down such a fully featured property, you have several strategies to fall back on in the event that one of your plans falls over.

For instance, three years down the track the capital growth you anticipated may not have materialised. If you then embark on a small renovation, you could increase the appeal of the property, which will “attract better tenants, who will want to stay for longer and who pay more”.

“I have a client and she and her husband earn just under $55,000 annually between them, yet they have five properties worth between $400,000 and $600,000 each. They get a great income as they’re renting their properties out by the room, getting an insane cash flow in the Brisbane CBD,” she says.

“These sorts of things are possible; it just comes down to your ability to be a little inventive about how you make the property give you extra cash.”

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 What's your alternative?

Instead of being won over by promises of high yields, opt for a ‘meat and potatoes’ property that delivers growth, yield and the potential to add value.

“Don’t chase the glitzy deals, the complicated subdivisions, or think about buying in America, or off the plan, or in a development that offers a rental guarantee,” she says.

“A tried and tested way forward is to stick with an average property that is boring, blah, bland, beige. This will be the type of property that’s going to appeal to a wide range of tenants and future buyers.

“At the end of the day, if it sounds really exciting, it’s not beige, so you should move on. From a low-risk point of view, you have worked really, really hard in saving your contribution to purchase this property, and you don’t want to flit that away on a risky deal.”

No-go investment #3: Student accommodation

 Why is it risky?

Even to experienced investors, student rentals can seem like a cash flow gold mine on the surface. But once you start digging a little deeper, it quickly becomes clear that some seriously profit-munching features are lurking behind the elevated returns.

Let’s take a real-world look at a student apartment that was recently marketed for sale on the Gold Coast. Listed for $235,000, the three-bedroom fully furnished property was rented for $165 per room, totalling a generous $495 per week – a gross yield of 10.95%.

So far, so good … until you review the outgoings.

Body corporate fees chewed through $70 per week. On-site management fees claimed another $75, and council rates and water a further $65. Factor in $20 per week for insurance, and your weekly maintenance expenses reach $230.

Almost half of the rental income is accounted for already, and you haven’t started paying the mortgage yet. What initially looks like a positive cash flow deal quickly becomes a money pit.

There’s also another unforeseen cost that investors often fail to factor in with student rentals, Slack-Smith warns: Christmas holidays.

“People forget that with the student accommodation market, students will often leave in November and the new tenants don’t arrive until February, so you’ll potentially deal with months of vacancies,” she says.

 How can you mitigate the risks?

This is one situation in which you can be guided by your lender, Slack-Smith advises.

Lenders are going to ask their own risk-mitigation questions, such as:

•  Can you rent it to someone else other than a student?
•  Can an owner-occupier live there?

“They know about these issues and they’re giving you a hint that it could be a problematic investment when they ask these questions,” she says.

“The only place this type of investment really does work is in a genuine university town, when students have to sign up to rent a property in May to secure a property for January the following year. When the demand is that strong, it can be a good investment.”

One of the main issues with student accommodation is that you’re limited as to who can live in the property, which limits your prospective tenant pool and constrains capital growth. The Gold Coast property cited earlier, for instance, was sold five years ago for $260,000, so it has actually gone backwards in value.

For this reason it’s essential that you review supply and demand at the suburb level, to ensure you’re not going to end up with a property that sits empty year-round and fails to appreciate.

“In Carlton in Melbourne, it’s uni central – there are 20,000 new units being built within a kilometre of the city,” Slack-Smith says.

“It’s having a huge impact. I was speaking to an agent recently and he said the student apartments that sold for $250,000 a few years ago are now on the market for $150,000. It’s really a risky market that people should exercise caution around.”

 What's your alternative?

You can enjoy the cash flow rewards of a student rental in a less risky way by shopping for an appealing home in a university town, and then privately renting that apartment out by the room.

With some personal door locks, some basic second-hand furniture and an internet connection in each room, a standard four-bedroom house that normally rents for $400 can be transformed into an attractive student haven that attracts a return of $150 per room.

If you decide to change your strategy down the track, you can offer your property for rent to the general population, and when it comes time to sell, your property will appeal to a wide range of potential buyers rather than being limited to student rental investors.

“It’s all about making sure you understand what the investment is, and then minimising your risk by trying to get it right the first time,” Slack-Smith says.

No-go investment #4: Anything up for auction

 Why it's risky

When you’re feeling under pressure to make a decision, that’s when you run the biggest risk of making a costly mistake, and there’s no property situation that applies more pressure than an auction.

“It’s a high-pressure environment so you need to have a really clear head,” says Marty Rankin, managing director of Village Real Estate in Melbourne.

“The numbers need to work for you, and you can’t buy with emotion and get caught up in the moment. When the hammer comes down, you’ve bought the property, and it’s not going to be subject to a valuation or finance clause.”

 How can you mitigate the risks?

If you’ve done your due diligence and found the ideal property, and you’ve made an offer prior to auction that the vendor has rejected, Rankin offers these tips to ensure you don’t invest over your head:

1. Leverage your lawyer

Having the contract checked by your solicitor or conveyancer isn’t just recommended, it’s crucial. “I’ve seen numerous occasions where people haven’t understood the adverse impact of a contract. General conditions are legislated under state and federal laws, but the special conditions are inserted by the vendor’s solicitors and can hide some nasties,” Rankin says. “For instance, the body corporate disclosure statement could reveal that a $15,000 special is coming up, which could be very costly if you don’t pick up on that.”

2. Dot every i and cross every t

“You need to make sure you’ve got all of your due diligence in place, which means ensuring your finance is approved and that the sale contract has been reviewed by your solicitor,” Rankin says. You should also arrange any building and pest inspections prior to auction, as the winner on the day will sign an unconditional contract that can’t be subject to valuation, finance or other conditions.

3. Set your budget to an odd number

When you’re setting a budget, most people finish on a round figure, such as $500,000. “Because a lot of buyers will stick to budget at a round number, it could be matter of $250 that allows you to purchase your property,” Rankin says. “Settle on a budget of something like $502,250 instead. You don’t need to beat the other buyer by $10,000; you just need to beat them by one bid, and if someone else is stuck at $500,000, this could get you across the line.”

4. Be confident

Even if you’ve never been to an auction before, you need to enter the situation as cool, calm and collected as possible. “Sometimes buyers can be intimidated by an agent, but don’t let yourself be pressured into purchasing anything if you don’t think it’s the right thing,” Rankin says. “Remember, there will be plenty of other properties available if this one doesn’t work out.

5. Negotiate terms before price

“I purchased a family house myself in 2007, and my offer was accepted even though it was $80,000 less than the highest bidder from the auction,” Rankin says. “The vendor preferred my settlement terms of 30 days, 10% deposit and a totally unconditional contract. The other offer was 150 days, 5% deposit and subject to finance, but because the vendor had already purchased elsewhere they were sick of paying two mortgages and more than ready to move on. It always pays to make sure you have an agreement on terms first, before price is negotiated, because it’s not always about the money.”

 What's your alternative

Take yourself out of the auction process altogether by approaching the vendor with an offer prior to auction day. If the vendor is not receptive or they reject your offer, and you’re not comfortable proceeding to auction, be prepared to move on – even if that means walking away after spending a small fortune on building reports, surveys and conveyancing advice.

“Sometimes, the right way for an investor to proceed is by doing nothing,” says Yardney.

“In fact, I’ve made more money by the things I’ve said no to over the years than the things I’ve said yes to. That’s because all my investments have been made as part of a planned strategy that involves property, finance and tax.”