The Rise of the Dark Side in a Hot Market

A hot market always brings new property spruikers and dodgy real estate sellers into the game. These people will use misleading data to create spooky wealth creation strategies. They’ll promise unlikely mortgage payoffs, tax benefits, unique SMSF setups, rental guarantee incentives, free services, off-the-plan promotions and so on.

I see potential investors get hooked into these ‘strategies’ as they yearn for free services, inspiration, and a dream home with a small budget. Everywhere they turn the spruikers will be offering their charm, using superficial marketing materials to promise the desired illusion.

Alternatively, some buyers will turn to real estate agencies or buyers advocates who only offer properties in a specific suburb or region. This works fine if you want to live in that particular location, but it doesn’t work in your favour when you are looking to invest in property.

Suburbs across Australia that represent a dangerous location for units:

Below is a table showing data from November 2021, listing the number of new units in the pipeline per postcode.
It indicates a heavy unit supply on those suburbs as the % of the existing stock in the market is noticeable.
All the areas have negative growth values over the last 12 months and the last 60 months.

Table 1

Source: Riskwise Property Review  

While some asset-classes are growing exponentially, other small products and especially apartments, are dropping in value or staying flat, with no change in sight.  Table 1 shows examples of 5 locations in 5 different states. The number of ‘New Units in the Pipeline’ shows how many new products will enter the market over the next two years and the percentage it represents from the ‘…Existing Stock’.  Those high existing stock percentages already affect the property vacancy rate and cash flow, in some areas around a 7% Vacancy rate is the reality.

It’s crucial to be wary of this kind of data and include it in investment risk analysis but it will never be provided by a seller or a consultant as it would threaten their business. Making investment decisions without considering this kind of information can result in unexpected and challenging long-term equity and cash flow problems.

Such high-risk suburbs are not scarce at all despite the market trend and there are many risky investment areas in every major capital city and state. We usually see clusters of new developments in these spots and many investment consultants and agents trying to make sales.

So, the question is, why is so much of the investment companies’ stock available particularly in the risky areas?

It’s not because it’s the best place for their clients to achieve great investment results.

It’s not because they reinvented the wheel and have a revolutionary theory on how to make money.

It’s not because they have connections with banks to allow you an 80% -90% LVR.

It’s not because they have intelligent brokers that can match property value to the purchase price.

It’s not because their acquisition department found a gold mine, and they wish to distribute the gold between their followers.

It’s not because the rental income is so good that you will be cash positive after the mortgage payments and heavy strata cost.

There is only one answer – they receive very high commissions!  

It is 3 or 4 times higher than 2 – 2.5 % which is the average agent commission.  And of course, when they get 8% commission for every sale, they will certainly use all their charm and resources to get the deal.

There can be a similar situation with second-hand sellers who, although they don’t receive high commissions, they still need to get the sales to make a living. When they sell to investors, they too will paint an unrealistic picture of the potential returns.

 

On the contrary here is a glimpse of low-density products in strong suburbs across the country:

Table 2 

The above postcodes have very low supply.  For example, in the Bli Bli area, there are about 80 new properties which represents only 2.7% from the existing stock.  In Springbrook there are only 30 properties in the pipeline which represents only 2.0% from the existing stock.

Imagine buying a few properties from investment firms based on their inspirational marketing material.  It will be exciting to have a selection of properties in an expanding and substantial portfolio, purchased with a genuine belief that you’ve made great investments.

Let’s analyse a common scenario…

Ten years ago, ‘John’ bought a lovely two-bed unit property in one of the inner suburbs of Brisbane. It overlooks

the river and is only 4km from the CBD. It’s close to most of the amenities and is conveniently situated only a very short commute to the airport.  There are various major infrastructures such as new roads and an airport upgrade which, along with the location and water proximity, are significant capital growth points for this property.

At the time of purchase, the sellers said that this will be a high value property in the future and that John can’t go wrong with this purchase, even if it’s without a good view or on the first floor. Although this isn’t exactly misleading over the long term, it is sold without any concrete data, and risk assessment or analysis of what the property is truly likely to return for John in the next 3 or 10 years.  This is a ‘hope strategy’ investment only.

John was inspired to buy a few more properties and create a strong portfolio. His mind is fixed on long-term success without questioning thoroughly.  A buyer like John is caught up in the inspiration of ‘wealth creation’ systems which are manipulative and have dubious long-term success.

So, what will happen?  All of John’s properties that he bought with the ‘hope strategy’ will stay on his portfolio and won’t grow very much, if at all.  After 5 – 6 years, John will look back and see that the properties that had compelling marketing reports didn’t move at all.  In fact, most of them will have reduced in value.

At the same time, other properties with more suitable asset classes, the correct configuration and the right location will be performing.

Over the longer term, John and his family will realise that their money is not working for them.  John had hoped that his portfolio would keep growing at least 4% a year and in a hot market maybe 12% or even 30%.   However, this isn’t happening as John invested in the wrong properties without risk validation, and now he can’t even sell them due to extreme oversupply. The only options are to keep holding it with yearly losses or to advertise it with a major discount (sometimes half of the original price) and sell it to other investors who are looking for a bargain.

This is not how we should invest in properties!  The ‘hope strategy’ is a big red flag and a major concern for any portfolio building.

 

A Personal Story of a Bad Investment

In my early days of investing, I also fell for this kind of ‘hope strategy’ and had to go through the experiences of having made a bad investment.

I bought two apartments from two investors who each wanted to resale their ‘off the plan’ units before settlement.  I was told by the selling agent that, for each property, I was buying $100,000 below what the property was worth.  Due to all the convincing marketing material and the intense ‘wealth creation’ brainwashing, I was very excited to include these properties in my portfolio.  They had all the fundamentals – the water view, a pool, BBQ area, train and ferry services nearby, etc.  In addition, the consultant explained that the owners would actually have loved to keep these investments, and that they were only selling due to severe illness and moving country.  It sounded like an excellent opportunity for immediate equity.

It was a hot market at the time, even in Brisbane, and many were queuing to buy fancy off the plan projects, especially the Chinese audience. Prices were very high compared to the second-hand market.  When I questioned that, I was told, “Yaron, we have 300,000 Chinese customers from Australia and China queuing up to buy in this location. If so many of them are buying here to get wealthy, they must be right.”

Initially, these two purchases of around 350K each seemed fined equity wise, as other similar new projects were selling at 400-450K.  But in real-time, when I refinanced to keep extending my portfolio, the real value was quite low, remaining at the same 350k mark that I paid.  A year or two later, I started to face rent reduction due to oversupply.  Then after more valuation attempts the property value was under 300K.  I asked the seller why he told me that the two properties I bought were 100K below the real price (as this was one of the key selling points that I fell for).  He told me that he still sees new projects with similar configurations that sell for 450k and 500k, and that it’s still an excellent long-term investment.  After a while, I forgot about the promises, the biased information, and the manipulative marketing. In 2020 and 2021, the valuation is 3/4 of the price on both properties, with low rent and negative cash flow.

Those properties are the weakest link in my portfolio.  While others are doing well, they ruin the cash flow and net equity and do not empower the portfolio at all.  Maybe they will improve in another 15 to 20 years, but it’s just not worth having them right now.

To summarise, be cautious.  Constantly assess your property risk.  Don’t take the glossy marketing materials or descriptions on real estate websites to be the whole truth.  Be smart if you want to make money from real estate and build a significant property portfolio. It is incredibly challenging, sometimes impossible, to right the wrongs, without losing money and without offsetting the years of loss.  Why buy a property if you’re going to lose money or be waiting too long for rewarding returns?