How to analyse an investment property

How to analyse an investment property

A How To Guide For Analysing Investment Property Opportunities

Choosing an investment property is a logical, not an emotional decision

Choosing a property to invest in should not be an emotional decision.

Yet, too often our gut feelings take over and the "but, I like ..." turns up. This leads to poor investment decision-making.

Investors need a structured yet simple framework for analysing investment properties. This is why we are sharing the top three criteria we use when examining investment opportunities.

Note: before we recommend a property to our clients, we run the opportunity through a 23-step pre-investment checklist. The three criteria in this article are based on the top steps within this checklist.

1) What's the asset worth, and what are you paying?

Billionaire Ric Kayne recently said:

"A good investment is when you can buy something for less than what it is worth. And so if you can buy a dollar for 50 cents, as ordinary as it is, that's a good investment."

At times, you may be able to secure a property for less than its value.

This can happen if the owner of the property needs to sell or has the desire to sell quickly.

New property developments are a great example of how this can work in practice.

Frequently, if you buy a new property – that hasn't been built yet – you can lock in today's price.

However, once you come to execute the transaction, say in a year (once the property is built), the market may have moved.

This means you are frequently able to pay a lower price than what the property is actually worth at the time of possession.

You may find there is also room to negotiate with the developer and pay a lower price than what you could sell the property for. This often happens early in the development's lifecycle, where you may be able to negotiate an incentive – for example a cash back.

Shameless plug: As part of the Opes three-step property coaching programme, we negotiate with developers on your behalf to get the best possible deal for you.

Of course, if you're not able to secure a property for less than its worth, then you shouldn't let that stop you buying an investment property.

The key is not to pay more than its value.

2) Is the asset likely to go up in value over time?

The next key indicator that will tell you whether a property makes a good investment is whether it is likely to go up in value over time.

Properties exist within regional, city-wide and suburban property markets.

So you want to invest in these markets that are likely to increase in value over time.

Because this article assumes that you are looking into a specific property already, we're going to look at suburban property markets.

If you want to discover which regional property markets we have the highest confidence in, check out the NPR Regional Rich List. This shows the areas of NZ we predict will make the best investment. (It was also recently published by Stuff).

What to Look for in a Suburban Property Market

A) Population Growth Within the Suburb

Population growth is the critical driver we always look at when predicting whether a suburb or city will achieve growth in property prices over time.

More people = more demand for houses.

More demand for houses = higher property prices.

If a city's population begins to concentrate in a particular suburb (or group of suburbs), you won't see any change in the city's population.

But, you would see population growth within these specific suburbs.

If you can identify areas of a city that are becoming more attractive to residents, then there is a chance to achieve growth in property prices within those suburbs.

Tip: Look for migration within a city's suburbs.

B) Employment and Industry

Next, you'll want to consider whether the property is in a high employment area.

Jobs attract people.

And, generally, people want to live near their places of work.

If you can buy a property in an area with lots of employment opportunities, people will likely want to buy your property when you come to sell.

However, don't just look at the businesses that are currently in the area. Consider the jobs that are likely to be created over the 20 years that you hold the property.

If you follow a buy-and-hold strategy, then you may not come to sell the property for another 20 years. And it can be hard to look that far ahead.

But, if you can see long-term positive trends towards employment, then this will bode well for your investment.

Tip: Look at where businesses in the city are moving too, specifically supermarkets and fast food chains e.g. Starbucks. These organisations undertake significant research before opening a store. So if they move into an area, it's a good sign.

C) Location to public amenities and infrastructure

Lastly, you want to think about whether the property you are looking into has other broad appeals that will make people want to live in that location.

If the property is well located, then people will likely want to buy the property from you in the future.

And in the meantime, it will mean that you're able to locate long-term tenants.

If you can see that the property is close to schools, gyms, parks, town halls, landmarks and other places people want to go to in their spare time, you know you're on to a winner.

3) Rental Market – can you hold the property with ease (i.e. can you avoid stress: emotional and financial)

Once you've satisfied yourself that the property is likely to increase in value over time, you'll want to be sure that you can hold on to the property.

There are two reasons investors exit the property market too early:

• Financial: They can't afford to hold on to the property over the long term
• Emotional: They can't handle the stress (if they've chosen the property poorly)

This is why when you are analysing a property to invest in, there are two additional areas we suggest looking into:

A) Financial: Cashflow Analysis – Can You Afford To Hold The Property

The primary factor that impacts whether you can hold on to a property is whether it is expected to be cashflow-positive, cashflow-negative or cashflow-neutral.

The answer to whether a property will require a contribution from you each week depends on how you have financed the property and structured the deal.

For instance, if you have borrowed 100% of the purchase price from the bank, then the investment is more likely to require a contribution from you.

If you use a 50% cash deposit, then it is more likely the property will be cashflow positive. That's because the interest costs you have to pay to the bank will be much lower.

There is no right or wrong answer, the key is:

• If your investment does require a contribution from you each week that you can afford that (or structure your portfolio to ensure you can afford it)
• That you are making the best use of any cash that you have at your disposal

The best way to run a quick cash flow analysis on a property – and to see what your contribution might be – is to use the Opes property investment calculator.

B) Emotional: Can you Attract Long-Term Tenants

The most significant stress (and biggest worry that most first-time investors have) is about whether they can attract good tenants.

That's because your investment income is the rent paid by your tenants.

The ideal situation is that you:

• Can charge a good amount of rent to your tenants
• That they pay the rent on time
• That they stay in your property over the long term
• They respect your property and look after it
• They don't cause damage to your property

From our experience, the best way to attract these types of tenants is by investing in newly-built properties.

That is because these types of tenants are so highly sought after that you'll want a property that is attractive to them.

Applying these criteria to an actual property.

Let's now apply these criteria to a property to see how this would actually work in practice.

We are currently recommending a set of apartments to our clients. These apartments, named Koto, are based in the Christchurch CBD.

1) What's the asset worth, and what are you paying?

The Koto apartments are valued between $425,000 and $450,000.

However, through our negotiation with the developer, we can offer them to our clients for $399,000.

Through this negotiation, we've secured $15,000 as a cashback from the developer. Our clients will receive this on settlement.

That means that for a total purchase price of $384,000, you can secure a property that is worth at least $36,000 more.

That's the equivalent of buying $1 for between 85 & 90 cents.

2) Is the asset likely to go up in value over time?

A) Population Growth Within the Suburb

Project 8011, an initiative from Christchurch City Council (CCC), recently caught my attention.

This project – named after the central city's postcode – is an effort by CCC to raise the CBD's resident population from just over 6,000 to 20,000 within the next decade.

The council is even considering a budgetary service to encourage residents to make a move.

Christchurch City Mayor Lianne Dalziel even said: "I kind of just want us to do it. I will move a recommendation that we just do it."

This suggests that CCC wants to increase the demand for properties within the CBD significantly.

This move is likely to raise house prices and rents in the central city, which bodes well for the future price of these apartments.

B) Employment and Industry

While we have been unable to source specific data about employment within the central city, we can spot general trends.

The Canterbury earthquakes gutted the central city. Businesses have left and with that – workers too.

But, walk through the city today, and you see shops opening; construction happening, and businesses moving back in.

Over the next 20 years, Christchurch's CBD will regenerate. Businesses and workers will return.

Given this long-term trend, we are confident jobs and businesses will appear close to these Koto properties.

C) Close to public amenities and infrastructure

These apartments are in a prime location. They are a 350-metre walk from Christchurch's new Town Hall, a 600-metre walk from the soon-to-open convention centre, and an 800-metre walk from Cathedral Square.

This means there is good access to infrastructure in the area, and the apartments will be perfect for people who want to live an urban lifestyle in the city.

3) Rental Market – can you hold the property with ease (stress and financial)

A) Financial: Cashflow Analysis – Can You Afford To Hold The Property

The primary factor that impacts whether you can hold on to a property is whether it is expected to be cashflow-positive, cashflow-negative or cashflow-neutral.

The answer to whether a property will require a contribution from you each week depends on how you have financed the property and structured the deal.

For instance, if you have borrowed 100% of the purchase price from the bank, then the investment is more likely to require a contribution from you.

If you use a 50% cash deposit, then it is more likely the property will be cashflow positive. That's because the interest costs you have to pay to the bank will be much lower.

There is no right or wrong answer, the key is:

• If your investment does require a contribution from you each week that you can afford that (or structure your portfolio to ensure you can afford it)
• That you are making the best use of any cash that you have at your disposal

The best way to run a quick cash flow analysis on a property – and to see what your contribution might be – is to use the Opes property investment calculator.

B) Emotional: Can you Attract Long-Term Tenants

We mentioned above that we prefer newly-build properties because they attract better quality tenants.

The Koto apartments are existing, not new, properties.

So, why are we still recommending these to our clients?

The Koto apartments were built in 2003. However, they have all been recently refurbished by a developer.

This means they are “like new”. Given the lack of properties available in central Christchurch – due to the earthquakes – we are confident they will be able to attract quality tenants. In fact, many of them are already tenanted.

While we have guiding principles and rules-of-thumb that we follow. We also believe you need to be flexible. You need to be willing to analyse different investment opportunities as they arise.